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uae research yearbook egypt sales team uae sales team ksa sales team research management Local call center 16900 call center +971 4 306 9333 call center +800 123 4566 Cairo General + 20 2 33 38 8864 Int’l call center +20 2 33 33 94 00 [email protected] [email protected] UAE General + 971 4 363 4000 [email protected] [email protected]
Head of Western Institutional Sales Western Institutional Sales Head of KSA Brokerage Head of Research Mohamed Ebeid Julian Bruce Hesham Khalil Philip Khoury +20 2 33 32 1054 +971 4 363 4092 +9661 211 3040 +971 4 363 4002 [email protected] [email protected] [email protected] [email protected]
Local Institutional Sales Head of GCC Institutional Sales Head of KSA Sales Head of Egypt Research Amr El Khamissy Amro Diab Mohsen Mansour Wael Ziada +20 2 33 32 1045 +971 4 363 4086 +9661 211 3008 +20 2 33 32 1154 [email protected] [email protected] [email protected] [email protected]
Gulf Sales UAE Retail Sales Head of Publ. and Distribution Ahmed Salem Reham Tawfik Rasha Samir +20 2 33 32 1078 +971 4 306 9418 +20 2 33 32 1142 [email protected] [email protected] [email protected]
disclosures
Disclosures by Stock Analysts We, Abid Riaz, Marise Ananian, Mohammad Madani, Monica Malik, Philippe Habeichi, Raj Madha, Sana Kapadia, Stefan Schurmann, Wael Ziada and Wafaa Baddour hereby certify that the views expressed in this document accurately reflect our personal views about the securities and companies that are the subject of this report. We also certify that neither us nor our spouses or dependants (if relevant) hold a beneficial interest in the securities that are traded in UAE Stock Exchanges.
Disclosures by Contributors to Strategy Section We, Fahd Iqbal and Hanzada Nessim hereby certify that the views expressed in this document accurately reflect our personal views about the securities and com- panies that are the subject of this report. We also certify that neither us nor our spouses or dependants (if relevant) hold a beneficial interest in any securities list- ed on the UAE stock exchanges.
Company Disclosures EFG-Hermes Holding hereby certifies that neither it nor any of its subsidiaries owns any of the securities that are the subject of this report. However, EFG-Hermes do own 1,431,105 local shares in Emaar as at 15 December 2007, one of the securities that are subject of this report. Funds managed by EFG-Hermes Holding and its subsidiaries for third parties may own the securities that are the subject of this report. EFG-Hermes may own shares in one or more of the aforementioned funds or in funds managed by third parties. The authors of this report may own shares in funds open to the public that invest in the securities mentioned in this report as part of a diversified portfolio over which they have no discretion.
The Investment Banking division of EFG-Hermes may be in the process of soliciting or executing fee-earning mandates for companies that are either the subject of this report or are mentioned in this report. disclaimer Our investment recommendations take into account both risk and expected return. We base our long-term fair value estimate on a fundamental analysis of the company's future prospects, after having taken perceived risk into consideration.We have conducted extensive research to arrive at our investment recommendations and fair value estimates for the company or companies mentioned in this report. Although the information in this report has been obtained from sources that EFG- Hermes believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. Readers should understand that financial projections, fair value estimates and statements regarding future prospects may not be realized. All opinions and estimates included in this report constitute our judgment as of this date and are subject to change without notice. This research report is prepared for general circulation and is intended for general information purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. It is not tailored to the specific investment objectives, financial situation or needs of any specific person that may receive this report. We strongly advise potential investors to seek financial guidance when determining whether an investment is appropriate to their needs. No part of this document may be reproduced without the written permission of EFG-Hermes. efg-hermes (egypt), 58 tahrir street, dokki, egypt 12311 tel +20 2 33 32 1140 | fax +20 2 33 36 1536 efg-hermes (uae), level 6, the gate, west wing, difc dubai - uae tel +971 4 363 4000 | fax +971 4 362 1170 efg-hermes (ksa), kingdom tower, 22nd floor, riyadh, saudi arabia tel +9661 211 0046 | fax +9661 211 0049 bloomberg efgh reuters pages .efgs .hrms .efgi .hfismcap .hfidom efg-hermes.com table of contents
EXECUTIVE SUMMARY p. 2
STRATEGY p. 4
ECONOMICS p. 18
BANKING UAE BANKING SECTOR p. 30 NATIONAL BANK OF ABU DHABI (NBAD) p. 34 ABU DHABI COMMERCIAL BANK (ADCB) p. 36 FIRST GULF BANK (FGB) p. 38 EMIRATES NBD (ENBD) p. 40 COMMERCIAL BANK OF DUBAI (CBD) p. 42 DUBAI ISLAMIC BANK (DIB) p. 44 ABU DHABI ISLAMIC BANK (ADIB) p. 46
OTHER FINANCIALS UAE HOUSING FINANCE SECTOR p. 48 AMLAK FINANCE housing finance p. 52 TAMWEEL housing finance p. 54 IAIC (SALAMA) insurance p. 56
TELECOM UAE TELECOM SECTOR p. 58 ETISALAT p. 62 DU p. 64
REAL ESTATE AND CONSTRUCTION DUBAI REAL ESTATE SECTOR p. 66 EMAAR PROPERTIES real estate p. 70 UNION PROPERTIES (UP) real estate p. 72 ARABTEC construction p. 74
UTILITIES AND ENERGY DANA GAS energy p. 76 TABREED utilities p. 78 AABAR ENERGY energy p. 80
OTHER ARAMEX logistics p. 82 RAK CERAMICS household goods p. 84 AIR ARABIA aviation p. 86 DUBAI INVESTMENTS COMPANY (DI) conglomerates p. 88 executive summary
macroeconomic outlook for 2008
The short to medium-term economic growth outlook for the UAE economy is very strong:We forecast 9.0% real GDP growth in 2008e and high single-digit growth until the end of the decade. With oil prices sustained at high levels, growth in government spending will continue to be strong (above 20%), providing support to private sector confidence in the economy. Investment will be an important driver of economic growth until the end of the decade and beyond, with Abu Dhabi playing an increasingly important role. The combination of continued expatriate population growth, negative real interest rates and robust consumer confidence should result in strong growth in private consumption. As a result of buoyant domestic and regional demand, we expect robust real non-oil GDP growth of 9-11% until the end of the decade.
While we forecast that the fiscal surplus will decline from historical levels due to spending growth outpacing revenue growth (assuming a Brent price of USD73.1 in 2008 and USD67.5 in 2009 vs. USD70.5 in 2007), it will remains strong at 23.0% of GDP in 2008 and 19.7% of GDP in 2009. We forecast an inflation rate of 7.6% in 2008 and 7.2% in 2009, with rental inflation in Abu Dhabi preventing any significant fall over the short to medium term despite the expectation of moderation in Dubai in 2008 and more so in 2009. The main risk to our outlook is further constraints on the supply of goods and labor, though broader risks include a sharp decline in the oil price and geopolitical tension with Iran. Lastly, the most important development on the external front is likely to be a shift in the currency peg and/or the currency regime which, although we believe will be of the order of 3% to 5% could well be of greater magnitude. We see a greater than 60% probability of either a revaluation of the AED/USD peg or an independent move to a currency basket in 1H2008. equity market drivers for 2008 oil price Oil prices are expected to remain comfortably above the levels required for fiscal break-even (approximately USD28 per barrel in 2008 and 2009 according to IMF estimates). Furthermore, few companies listed on the stock market have direct exposure to the oil price. Therefore, we see little fundamental direct downside risk over the medium term to either the economy or to listed companies from a sharp contraction in oil prices. Of course, a substantial number of private sector businesses operating in the UAE are dependent on revenues from oil-producing countries that have significantly higher break-even oil prices.While historical daily and weekly correlation between stock markets and oil prices has been low, we expect this to change with the increased influence of Western investors some of whom perceive (we believe wrongly) that the equity markets of the GCC to be a short-term oil play. investor appetite Western institutions have been instrumental in driving markets higher in 2007 and we believe their importance will only grow in 2008, with the bias moving increasingly from "fast money" proprietary desks and hedge funds to long-only mutual funds. This should be supported by the ongoing liberalization of ownership of listed companies. The inclusion of the UAE and the broader GCC within international indices should also help to increase international awareness of the region. As the year progresses, the increased penetration of Western investors should result in an increased focus on small & mid caps and stock picking in general, greater demand for corporate governance, and higher correlation with global emerging markets - although we do not believe that the extent of the latter will be sufficient to remove the benefits of diversification for international investors.
For retail investors, we believe earnings growth will continue to be the primary driver and momentum-driven behavior will continue, with some herding behind the Western institutional flows. Our expectation of a recovery in Saudi Arabia in 2008 suggests the re-entry of (liquid and active) Saudi retail investors into the UAE. However, if the Saudi market were to open up broadly to foreign investors (as we expect it to) then liquidity and the attention of Western institutions would be most likely diverted from the UAE, albeit for a while. ipo activity We expect a substantial increase in IPO activity over 2008, driven by both higher prices and volumes.The listing of DP World suggests further part-privatizations are in the pipeline and a recent change in regulations, reducing the minimum level of free float required to conduct an IPO from 55% to 30%, should spur the listing of family businesses. The increase in listings should provide greater sectoral breadth to the market. We see new listings as critical in generating new investment opportunities and attracting fresh liquidity, particularly from Western institutions. We would therefore view the failure of a number of IPOs to materialize as being materially negative for the UAE markets. earnings growth Earnings expectations are fundamental in determining our outlook for the markets. While our overall expectation of 26% nominal CAGR 2007-09e in earnings may appear somewhat modest given the UAE's compelling growth outlook, our numbers are heavily influenced by our forecast of a slowdown in the heavily weighted banking sector due to increasing loan penetration and rising competition. In contrast, we forecast that sectors outside of the financial sector will see an earnings CAGR of 43% 2007-09e. 2 uae research yearbook 2008 uae research yearbook 2008
mergers and acquisitions We expect M&A activity to increase over 2008. Fragmented sectors (cement and insurance) are the most likely candidates for consolidation and vertical integration, while companies operating in saturated sectors (real estate and telecoms) are likely to expand into related sectors and geographies. The banking sector is likely to see elements of both, with more domestically focused banks looking towards consolidation and larger banks engaging in expansion across the MENA region. real estate According to our estimates, real estate prices witnessed a slower rate of appreciation in 2007 than in 2006. We have revised our forecasts, given that in 2007 the supply of residential units fell markedly below our initial expectations. We now forecast that real estate prices will increase 5-10% on average in 2008, followed by a cumulative decline of 15% over 2009-11e. Key variables are the pace of supply of housing units, the demand for housing / the rate of immigration, the impact of a revaluation of the AED. A shift in the dynamics of the real estate market would likely feed through to the stock market through the listed real estate developers, the banking sector and investor sentiment. us dollar peg We believe the overall impact of either a revaluation of the USD/AED peg or a move to a currency basket will be limited but positive. Given that the UAE is not an exporter of manufactured goods and that the consumer is not well represented on the stock market, we anticipate little change in revenues. Demand for real estate from non-resident buyers may be tempered by the effect of a revaluation but this is, to a certain extent, already incorporated in our price and demand forecasts. We believe the main impact will come through costs, with an easing of wage inflation measured in local currency, imports from non-USD pegged countries becoming cheaper, and the cost of servicing non-AED denominated debt decreasing. valuation The UAE remains attractively valued at 13.0x 2008e and 9.9x 2009e earnings. Dubai trades at a substantial discount to Abu Dhabi, though this is explained by the exclusion of the Abu Dhabi real estate companies that we do not yet cover and the negative investor sentiment towards Emaar. outlook and recommendations for 2008
We are bullish for 2008 and expect the share price momentum seen in the last two thirds of 2007 to be sustained through a further influx of Western institutional investors, ongoing liberalization of ownership, a substantial increase in IPOs, and a pick up in M&A activity. Over the course of the year, we expect to see a greater focus by investors on small & mid cap ideas and stock picking generally, corporate governance and transparency, all of which will be key in determining share price performance. Our target PE multiples of 16.1x 2008e and 14.0x 2009e provide us with potential upside of 23% to 42%.
The main variables to our view are related to liquidity; i) the strength of Western institutional inflows, ii) the impact of a recovery in the Saudi market on the behavior of Saudi retail investors in the UAE, iii) the opening of the Saudi market to foreign investors, iv) the extent to which IPOs will materialize, v) the outlook for the real estate sector, and vi) the extent of the revaluation of the AED and its impact.
Significant exogenous risks include: i) the possibility that the turmoil in US credit markets could hamper the ability of companies and banks to raise international capital so as to fund acquisitive growth plans and lending, respectively, and ii) that a military strike against Iran would likely lead to an initial panic sell-off. In this eventuality, we would expect investors to return to the market in strength assuming UAE crude production facilities are unaffected as the sharp increase in oil prices that one would expect in the event of a strike on Iran would provide significant resources to the UAE authorities to counteract a decline in private sector confidence.
In terms of stock picks for 2008, we advise exposure to a mixture of attractively valued blue chips and midcaps that offer high growth. Our top picks are: Emaar, whose stock price performance we believe has significant scope to surprise positively in 2008, Arabtec, Union Properties, Etisalat, Emirates NBD, Commercial Bank of Dubai, Aramex, Air Arabia and Tabreed. Stocks we would be underweight are Dubai Investments and Amlak. Finally, we also highlight Aabar Petroleum, RAK Ceramics, and Abu Dhabi Islamic Bank as stocks to keep on the radar screen.
executive summary 3 strategy
2007 top-down view
2007 was a remarkable year for the UAE stock markets. Both Abu Dhabi and Dubai underwent two strong and distinct rallies, pushing the markets to broadly outperform the rest of the GCC - an impressive feat considering the performance posted by other GCC markets Year-to-Date. While in our 2007 Yearbook, published in mid-January 2007, we had forecast a recovery to occur in 2007, the scale of performance was ahead of our expectations.
The recovery was supported primarily by new listings, increased foreign investor participation, and rising earnings growth marked with improving quality. These positive factors came together against the backdrop of a very strong economic environment, backed by high and rising oil prices, negative real interest rates, high liquidity, a current account surplus and growing government expenditure.
Fig 1: Oil Price versus Effective Federal Funds Rate Fig 2: GCC Performance YTD (to 11-Dec-07)
90 Crude Brent Oil Prices, USD 7 180 Saudi Arabia Tadawul Index Kuwait All Share Index EFFR (RHS) 80 6 Qatar DSM20 Index 160 Oman MSM30 Index 70 EFG-Hermes Dubai Index 5 Bahrain All Share Index 60 140 EFG-Hermes Abu Dhabi Index 50 4
40 3 120 30 2 20 100 1 10 80 0 0 Sep-07 4Q97 4Q98 4Q99 4Q00 4Q01 4Q02 4Q03 4Q04 4Q05 4Q06 Jan-07 Feb-07 Apr-07 May-07 Jun-07 Jul-07 Oct-07 Dec-06 Mar-07 Aug-07 Nov-07 Source: Bloomberg, IMF (International Financial Statistics) Source: Reuters, EFG-Hermes
Oil prices rose sharply over the year to reach nominal highs of close to USD100/bbl, up from USD60/bbl at the beginning of the year. The windfall petrodollar revenues continue to bolster the economic plans of both Abu Dhabi and Dubai. Dubai continued with its current investment-driven economic policy and moved to its Five Year 2015 plan (given that the 2010 plan was completed ahead of schedule). Abu Dhabi, on the other hand, announced an important shift in fiscal policy with a substantial increase in planned development and investment expenditure. The plans were detailed in the launch of "Plan Abu Dhabi 2030" and, following Dubai's example, were accompanied by a change in property ownership laws that now allow foreigners to purchase real estate in the emirate.
In the US, the Federal Reserve cut interest rates by 100bp in the face of a growing credit crisis. With the AED pegged to the dollar, the UAE Central Bank cut rates in response also. With inflation running at 9.3% in 2006 and an estimated 8.7% in 2007, these actions pushed real interest rates deeper into negative territory.
The combination of negative real interest rates and high oil prices increased liquidity materially and contributed to stock market momentum. Foreign investor inflows added a further boost to liquidity, resulting in both Abu Dhabi and Dubai witnessing record high levels of value traded. stock market performance summary The year began with a continuation of the subdued market performance witnessed in 2006. A marked divergence between the EFG- Hermes Abu Dhabi and Dubai indices was triggered in March by Emaar's announcement of a land-for-equity swap with Dubai Holdings. The subsequent negative investor sentiment, which seems to have persisted till today, put significant downward pressure on bellwether stock Emaar and therefore the Dubai index overall. It is worth noting that the divergence between the two indices is unusual, both in terms of scale and duration.
The UAE markets bottomed out in April, triggered by better than expected corporate earnings results. We have highlighted the importance of earnings announcements in the past and the trend is evidenced by the concentration of both rallies around the post- results season period. On a year-to-date basis, the EFG-Hermes Abu Dhabi Index is up 67% (the best performing in the GCC) and the Dubai Index 44%.
4 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
Fig 3: Performance of the UAE,YTD (to 11-Dec-07) Fig 4: Traded Value, 20-day Moving Average (AED m) Abu Dhabi Value Traded (20d MA) 170 5,000 EFG-Hermes Dubai Index (re-based) Dubai Value Traded (20d MA) EFG-Hermes Abu Dhabi Index (re-based) 160 4,000 150 140 3,000 130 120 2,000 110
100 1,000 90 80 0 Apr-07 Feb-07 Jan-07 Jun-07 Jul-07 Sep-07 Jun-07 Oct-07 Dec-06 Mar-07 Aug-07 Sep-07 Dec-06 Mar-07 Nov-07 May-07
Source: Reuters, EFG-Hermes Source: Reuters, EFG-Hermes
Western institutional investors played a key role in both rallies. These investors were initially attracted by the recent crash, which resulted in a mass exit of speculative liquidity and left the broader market trading at attractive low-teen valuation multiples.Of particular interest was the under-penetration by Western investors that offered excellent diversification benefits. The robust appetite for emerging market exposure led to strong Western institutional inflows, and was further supported by a number of companies increasing the number of shares open to foreign investors. International awareness of the UAE stock markets was also raised by roadshows, hosted by the Abu Dhabi and Dubai stock exchanges, to established financial centres such as London and New York. More recently, the UAE has benefited from the credit turmoil in the US as further funds were redirected towards emerging markets in general and the region in particular.
The correlation between the UAE and emerging markets has historically been weak, however in recent months a positive and rising correlation has developed. As Figure 5 illustrates, Abu Dhabi has witnessed a stronger correlation for several reasons: (i) the launch of Plan Abu Dhabi 2030 diverted investor attention onto Abu Dhabi real estate stocks, at a time when investor sentiment towards Dubai real estate was negative due to Emaar; (ii) property developers Aldar and Sorouh opened their shares to foreigners; (iii) the Abu Dhabi- listed banks have greater openness to foreign investors, compared to Dubai; and (iv) high and rising oil prices led to demand for exposure to energy assets, for which there are greater listings in Abu Dhabi than Dubai.
Fig 5: Correlation of Abu Dhabi & Dubai Fig 6: Performance of GCC and Emerging Market Indices to the MSCI Emerging Market Index YTD (to 11-Dec-07)
Correlation of EFG-Hermes Dubai Index to 40% MSCI Emerging Market Index 100% Correlation of EFG-Hermes Abu Dhabi 30% Index to MSCI Emerging Market Index 80% 20% 60% 10%
0% 40%
-10% 20% -20% 0% -30%
-40% -20%
Peru
India Chile
Brazil Egypt Saudi Israel China Dubai Qatar Korea Oman
Poland Russia Kuwait Jordan Turkey Mexico Taiwan Tunisia Bahrain
Morocco Hungary Lebanon Pakistan Malaysia Thailand
Oct-07 Sri Lanka Aug-07
Colombia Nov-07
May-07 Indonesia Jan-07 Feb-07 Mar-07 Apr-07 Jun-07 Jul-07 Sep-07 Argentina
Dec-06 Venezuela Abu Dhabi
Philippines
Czech Republic SouthAfrica
Calculations are based on 50-day rolling correlations Source: Reuters, Bloomberg, EFG-Hermes calculations Source: Bloomberg, Reuters and EFG-Hermes
strategy 5 strategy
2007 bottom-up view sectoral performance All sectors have seen a strong positive performance year-to-date, with the notable exception of insurance. The Energy & Utilities sector saw the strongest performance, backed by high earnings growth and, we believe, demand for oil price exposure. Banks & Financial services as well as Real Estate & Construction saw a robust performance supported by new listings, a relatively high exposure to foreign ownership, and a sturdy real estate market.
With Financials accounting for over 40% of the index and Real Estate a further 25%, the positive performance of these sectors had a significant impact on the market overall. Telecoms rose by roughly 20%, thus underperforming the UAE, but this could be largely attributed to restrictions on foreign (and institutional) ownership in Etisalat. Finally, the Insurance sector fell slightly over the year, though we believe this was driven more by the sector's low liquidity, which resulted in a wide distribution of share price performance across the sector.
Fig 7: UAE Performance, by Sector YTD (to 11-Dec-07) Fig 8: Split of Market Cap and Value Traded, by Sector YTD 60% 100% 90% 50% 80% 40% 70% 60% Others 30% Industrials 50% Telecoms 40% Real Estate & Cons'n 20% Banks & Financials 30% 10% 20% 10% Market Val Traded Market Val Traded 0% 0% Cap Cap -10% 2006 2007 Utilities Energy & Energy Telecoms Insurance Consumer Industrials RE & Cons. RE & Investment Healthcare UAE Markets UAE Banks & Fin. Source: Reuters, EFG-Hermes calculations Source: Reuters, EFG-Hermes calculations sectoral composition Figure 8 illustrates the breakdown of market capitalization and value traded over 2006-07. The split by market cap has remained relatively unchanged through 2007, reflecting the comparably strong performance across the largest sectors. However, in terms of value traded there has been a shift away from Real Estate & Construction, as the significant reduction in trading of Emaar over the year could not be offset by the increase in interest in Aldar Properties, Sorouh and newly listed Deyaar. Much of the liquidity flowed into the Consumer and Industrial sectors due to the listing of Air Arabia and Gulf Navigation. performance of individual stocks Although very few stocks delivered a negative price performance over the year, the best performing stocks (as highlighted already) were IPOs or stocks open to foreign investors.
In Dubai, newly listed Dubai Financial Market, Deyaar and Air Arabia were the best performing stocks, year-to-date. Dubai Financial Market (open to foreign investors) increased by more than 500%, with Air Arabia (also open to foreign investors) following suit. The strong performance of Deyaar (closed to foreign investors) highlights the continued strength of local investor interest. In Abu Dhabi, newly listed Arkan (closed to foreign investors) was the best performing stock, surging more than 200%. Aldar and Sorouh were also among the best performing stocks with the bulk of the performance taking place after both companies opened their shares to foreign investors.
6 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
Fig 9:YTD Performance of Stocks in EFG-Hermes Abu Dhabi Index Fig 10:YTD Performance of Stocks in EFG-Hermes Dubai Index
600% 600% 500% 500% 400% 400%
300% 300%
200% 200%
100% 100% 0% 0% -100% du DIB* IAIC* DFM* Deyaar Amlak* Emaar* Taqa ADIB FGB* Arkan UNB* Aramex* Arabtec* Gulf Nav Tabreed* Aldar* Aabar* ADCB* Tamweel* Etisalat NBAD* Air Arabia* Air Sorouh* Union Prop.* Dubai Invest.* Dana Gas* Dana RAK Prop.* Oasis Cap.* Oasis Gulf Cement* Gulf *Companies opened to foreign ownership *Companies opened to foreign ownership Source: Reuters, EFG-Hermes Calculations Source: Reuters, EFG-Hermes Calculations earnings growth The past couple of years have seen a significant distortion in reported earnings growth numbers due to companies investing heavily in the stock market.The stock market boom and subsequent bust led to a significant deviation in reported numbers from actual underlying growth. In 2007, however, much of the exposure to the stock market appears to have washed out, resulting in reported earnings growth being much more reflective of underlying growth.
As Figures 11 and 12 highlight, the past three quarters have seen Abu Dhabi and Dubai deliver positive and, in general, increasing earnings growth numbers. Although growth is well below the peak levels reached in 2005, it is nevertheless impressive.This is especially so when considering that growth was predominantly driven by the operating line, indicating strength in core business activities.
Fig 11: Reported and Underlying Earnings Growth in Abu Dhabi Fig 12: Reported and Underlying Growth in Dubai 180% 180% Reported Earnings Growth 160% 160% Earnings Growth Excl. Market Related Gain Earnings Growth Excluding Market Related Gain 140% 140% Reported Earnings Growth 120% 120% 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% -20% 1Q2004 2Q2004 3Q2004 4Q2004 1Q2005 2Q2005 3Q2005 4Q2005 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 3Q2007 1Q2004 2Q2004 3Q2004 4Q2004 1Q2005 2Q2005 3Q2005 4Q2005 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 3Q2007 Source: Company disclosures Source: Company disclosures
strategy 7 strategy
2008 top-down view a. oil price Oil prices reached record highs in 2007 driven by a combination of limited spare production capacity, geo-political instability, and a falling dollar. Brent crude averaged USD71.7 over the year (versus USD65.5 in 2006), and at present consensus oil forecasts point to USD74.0 for 2008e and USD71.6 for 2009e. What is important, however, is the fiscal budget break-even level measured in terms of the oil price which, according to IMF forecasts (which incorporate all oil revenues and investment income), is USD27.6 for 2008e and USD28.2 for 2009e.Therefore, we believe current risks to the economic backdrop to be limited. Even in the face of a sharp contraction in oil prices, we believe the economic risk is greater over the medium-term rather than the short-term due, firstly, to the long-term nature of the fiscal plans underway and, secondly, to the substantial build-up in foreign currency reserves over the past few years.
Fig 13: Increased Correlation between Fig 14: Average Oil Price versus UAE Fiscal Break-Even Levels the Oil Price and Abu Dhabi, Dubai Indices EFG-Hermes Dubai Index (re-based) EFG-Hermes Abu Dhbai Index (re-based) Average Brent Crude Oil Price 110 Brent Crude Oil Price (RHS) 80 Fiscal Breakeven Oil Price (IMF estimates) 70 100 Low correlation High correlation 100 period period 60 90 90 50 80 80 40 70 70 30 60 60 50 20 50 40 10 40 30 0 2004 2005 2006 2007 2008e 2009e Jul-07 Jan-07 Jun-07 Apr-07 Feb-07 Sep-07 Sep-06 Oct-07 Oct-06 Dec-06 Mar-07 Aug-07 Aug-06 Nov-07 Nov-06 May-07 Source: Bloomberg, Reuters Source: Bloomberg, EFG-Hermes
Historically, the lack of direct listed exposure to the oil price has led to low levels of correlation between the oil price and GCC stock markets. However, this has changed in recent months as the influx of foreign investors has resulted in an increased perception of a link.The potential of an oil price-led correction in the stock markets has therefore risen, but fundamentally we continue to see little downside risk. b. investor appetite In previous years, investor appetite was driven almost entirely by local retail investors. However, 2007 was unusual in that it was driven mainly by new entrants to the market - Western institutions. Going forward, we see the dynamics between retail and institutional investors to be far more important determinants of stock market performance.
Fig 15: Net Purchases on the DFM by Local, Arab Fig 16: Net Purchases on the DFM by Retail and Foreign Investors and Institutional Investors
(AED '000) Arab & GCC Foreign UAE (AED '000) Institutional Retail 6,000 5,000 4,000 4,000 3,000
2,000 2,000 1,000 0 0 (1,000) (2,000) (2,000)
(4,000) (3,000) (4,000) (6,000) (5,000) July May June July April May June April March August March August October October September Source: Dubai Financial MarketSeptember Source: Dubai Financial Market
8 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
Western Institutions The key role played by Western institutions in driving markets over 2007 can be seen in Figures 15 and 16, as the two rallies seen this year have coincided precisely with the strong net buying activity of foreigners and institutions. Going forward into 2008, we believe this class of investor will only grow in importance. The UAE's status as a frontier market (i.e. a nascent stage emerging market) will ensure that investors with high levels of risk appetite, such as hedge funds, will always have a presence. However, we expect the mix in Western institutions to move increasingly towards long only mutual funds as the GCC becomes a better understood and more firmly entrenched member of the emerging market universe. This transition is evidenced by the increased number of GCC-centric funds currently being launched by international fund management groups.
We anticipate that the rising penetration of Western institutions will be supported by two distinct themes. The first is the continued opening up of the shareholder base to non-GCC investors. This would be driven by companies seeking a broader investor base, due either to the sheer size or the regional ambitions of the company in question, and also from top-down regulatory pressures. It is worth highlighting that on this latter point, the government has alluded to a change in the Companies Law that could potentially allow 70-100% foreign ownership in some sectors.
We hope for further clarity on this in 2008.The second theme is the inclusion of the GCC within international indices. Recently, both MSCI and S&P have launched frontier market indices and it is interesting to note that in both cases the UAE is the dominant country1. We find this highly encouraging and expect it to continue to help draw investor attention to the UAE.
The influx of foreign investors should lead to some interesting changes in the UAE stock markets and we highlight three of the most important ones: (i) as Western investors become more comfortable with investing in the UAE, their focus should move away from blue chips towards small & mid caps, where greater alpha generating opportunities exist - this would ultimately help distribute liquidity more evenly across the market; (ii) increasing demand for an improvement in corporate governance, resulting in room for a divergence in performance between stocks that engage in good and bad practices; (iii) greater correlation with global emerging markets, though not to an extent that would remove the UAE's diversification benefits to international investors.
UAE Retail Liquidity in the UAE is still dominated by retail investors who continue to follow a highly speculative investment strategy. This is evidenced by the sheer scale of activity in stocks that are closed to foreign investors (such as Deyaar) and their net selling actions during the two strong rallies in the market.We therefore expect quarterly reported earnings growth to continue to be the primary driver behind local retail sentiment.
In addition to this however, we believe the momentum-driven nature of local retail will result in herding behavior behind the actions of Western institutions. Although this will contribute somewhat to increased volatility, we also expect it to help increase liquidity in small & mid cap stocks once Western fund manager attention turns in that direction.
Saudi Retail At the peak of the market, it is estimated that as much as one-third of value traded in the UAE was accounted for by retail investors from Saudi Arabia. However, these investors have been notably muted since the Saudi market started crashing in early 2006. Given our expectations for a 2008 recovery in Saudi Arabia (see "Time to Revisit", published 7 November 2007), we see a strong likelihood of this changing and we could therefore see Saudi retail investors playing a more prominent role. On the downside, if the Saudi market were to be opened wide to foreign investors, we believe liquidity could temporarily be diverted away from the UAE. c. ipo activity The majority of IPOs slated for 2007 were postponed with "weak market conditions" cited as the most common cause. However, all five stocks that listed during 2007 were over-subscribed, have commanded healthy liquidity, and have comfortably outperformed the benchmark index since listing, suggesting many companies were overly cautious in their decision not to list.
With stock markets notably healthier, positive investor sentiment, and interest coming from Western institutions, we anticipate 2008 to be a substantially stronger year for listings. This view is supported by two key recent events. The first was the federal decree allowing family companies to float a minimum of 30% of their capital, versus the previously required minimum of 55%. By allowing families to maintain majority control, listing has become a far more attractive option than before. The second was the successful part-privatization of DP World, which helped attract significant levels of international investor interest. As a result, we would expect to see further similar listing plans from other large state-owned enterprises, such as Emirates Airlines and Nakheel. Moreover, the successful use of a book-building process could encourage a more widespread uptake across the UAE. Not only would this help improve price efficiency and volume stability, it would also encourage companies to improve corporate governance so as to assure a healthy premium to book value upon listing.
1For further details, see http:// www.msci.com/consultation/frontier_markets_indices_Aug2007.pdf and http:// www2.standardandpoors.com/spf/pdf/index/sp_IFCG_Extended_Frontier_150_Factsheet.pdf strategy 9 strategy
Table 17: Announced IPOs in the UAE Table 18: Rumored IPOs in the UAE
Issuer Subscription Sector Offering Equity Issuer Subscription Sector Offering Equity Period Size Offered Period Size Offered (USD m) (USD m) Al Nahda Int'l Education Co 1Q2008 Services 214 38.5% DEPA United Group H1 2008 Construction 400 - Damas Jewellery 1H2008 Consumer Goods 272 25.0% Abu Dhabi Vegetable Oil Co 2008 Agriculture and Food - - Al Qudra Holding 2008 Conglomerates - 30.0% Future Pipe Group 2008 Basic Materials 109 - Abu Dhabi Holding 2008 Financial Services - - M'sharie 2008 Financial Services - - Rasmala Investments Holdings 2008 Financial Services - - Abu Dhabi Securities Market 2008 Financial Services - - Int'l Petroleum Investment Co* 2008 Financial Services 545-817 - Al Mansoori Specialized Eng. 2008 Oil and Gas - - Dubai Bank 2008 Financial Services - - Emirates Central Cooling Sys. Corp 2008 Power and Utilities - - Abraaj Capital 2008 Financial Services - - Dubai Aerospace Enterprise* 2008 Transport - - Showtime Arabia 2008 Media - - The National Investor 2009 Financial Services - - Middle East Broadcasting Corp 2008 Media - - RAK Petroleum 2008 Oil and Gas - - Palm District Cooling 2008 Power and Utilities - - Thuraya Satellite Telecoms Co 2008 Telecoms and IT - - Emirates Post* 2008 Transport - 49.0% Emirates Airline* 2008 Transport - 20.0% DAMAC Holding 2009 Conglomerates - - Nakheel 2009 Real Estate - - Rotana Hotel Management Corp 2010 Travel and Tourism - - *Represents part-privatization *Represents part-privatization Source: Zawya Source: Zawya
The above points are reflected in Tables 17 and 18 which list announced and rumored IPOs in the UAE. In our view, one of the factors that have frustrated many investors, especially Western institutions, has been the difficulty in gaining exposure to areas outside of the dominant telecoms, banks and real estate sectors. In particular, there has been considerable demand for exposure to the areas that have helped define the UAE's economic success, such as tourism, retail, leisure, transport, energy and trade. As the tables above indicate, increased listings over the next few years should address this imbalance.
It is important to point out the lack of data availability, even for announced IPOs. This suggests some uncertainty over the exact timing of these IPOs, or indeed whether they will actually go ahead or not. We see new listings as being crucial in sustaining the momentum behind Western institutional investor flows. With the majority of trading concentrated in a handful of stocks, new listings are required to generate additional investment opportunities and attract fresh liquidity. We would therefore view the failure of a number of IPOs to materialize as substantially negative for the UAE. d. earnings growth With stock market performance showing a strong correlation with reported earnings growth (and of course with reported earnings growth now more indicative of growth in core activities), our earnings growth forecasts are a key factor in our overall outlook for the market.
Fig 19: EFG-Hermes Earnings Growth Outlook Fig 20: The Relationship between Stock Market Performance and Earnings Growth
100% 07-08e 08-09e 09-10e 10-11e 120% UAE Market Earnings Growth 24,000 EFG-Hermes UAE Index 80% 100% 22,000 60% 20,000 80% 40% 18,000 60% 20% 16,000 0% 40% 14,000 -20% 20% 12,000 -40% 0% 10,000 -60% UAEBanks R eal Estate & Telecoms Energy & Industrials Jun-06 Jun-07
Construction Utilities Sep-06 Sep-07 Dec-05 Dec-06 Dec-07 Mar-06 Mar-07 Source: company reports, EFG-Hermes Source: Company reports, EFG-Hermes
10 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
On the basis of our analysts' forecasts, we see earnings growth of 21.2% 2007-08e and 31.7% 2008-09e for the UAE overall. However, there are two factors to note here: (i) our numbers are somewhat skewed by the banking sector which accounts for 40% of our coverage universe by market cap. Given the high loan penetration and the prospect of increased competition (both from local and international players), we expect downward pressure on profitability and therefore earnings growth. (ii) Due to the timing of real estate project deliveries (and the use of completed contract accounting by Union Properties), earnings growth in the real estate sector is expected to report strong growth in 2009e followed by negative growth in 2010e.
Therefore, looking at financials and non-financials separately, we see that non-financials are expected to grow earnings by 35.9% 2007- 08e and 51.0% 2008-09e. This compares to financials where we see 8.4% growth 2007-08e and 11.2% 2008-09e. e. mergers and acquisitions M&A activity had a slow start in 2007 with the merger of Emirates Bank and National Bank of Dubai to form Emirates NBD. We see greater focus on acquisitive growth in 2008 as both domestic and foreign competition picks up. Such events should help spur value traded in the companies involved - as the experience with Emirates NBD suggests, the impact could be substantial: shares increased 50% in the week the combined entity was listed. We expect to see M&A activity follow a dichotomous trend across the market, with consolidation among the more fragmented industries (cement and insurance) and regional and/or sector expansions in more saturated markets (telecoms and real estate).
The UAE cement sector lacks an export market and the combination of rising raw material prices, a government imposed price cap, and looming over-capacity regionally suggest that the ongoing margin weakness will continue. We therefore believe that the main respite in the industry will come from consolidation and vertical integration.
Within insurance, some 40 companies are vying for the bottom 60% share of the market and consolidation is therefore a logical outcome. We believe Islamic insurance (takaful) companies in particular are likely to follow this avenue given they control a mere 3% of the market. Acquisitions offer a straightforward means to quickly increase this figure. Islamic Arab Insurance (IAIC), which is heavily capitalized, has indicated that it intends to carry out two acquisitions a year, though none have materialized so far. Please note that IAIC is not entirely representative of the insurance sector, given that the UAE forms less than 10% of its overall earnings and its acquisitions will therefore be regionally focused.
Both the telecoms and real estate companies (developers and contractors) operate in fast growing markets where a slowdown in the medium term is expected. As a result, we expect a focus on acquisitive growth outside of the core domestic markets. Etisalat has followed a strategy of pursuing growth in underpenetrated emerging markets and we therefore expect the company to continue focusing on expanding across the Middle East, South Asia and North Africa. We do not expect to see acquisitive growth from du, which is more likely to continue concentrating on its start-up UAE operations.
Within real estate, we see construction company Arabtec following its current strategy of expanding internationally through acquisitions and joint ventures in order to reach its target of generating 40% of revenues from outside the UAE. Emaar also has ambitious regional expansion plans and this has so far been attained through a mix of acquisitions, JVs and Greenfield developments. Union Properties' international exposure is at present is derived primarily from the franchise rights to develop the Formula 1 theme park worldwide. However, further diversification into other emirates and the broader GCC, through property developments, is also on the agenda.
Finally, the banking sector is likely to see elements of both expansion and consolidation. The sector as a whole remains over-capitalized (led by First Gulf Bank and Commercial Bank of Dubai) and, as a result, most players are targeting some level of acquisitive growth. Large cap banks, National Bank of Abu Dhabi and Emirates NBD, are focused on opportunities within the MENA region. Both First Gulf Bank and Abu Dhabi Commercial Bank have aggressive growth plans and we therefore believe both are more likely to be acquirers than targets. We see less acquisitive potential from Commercial Bank of Dubai, since it is currently looking to increase its domestic franchise; and Abu Dhabi Islamic Bank, which is under new management and integrating its recent acquisition of Egypt's National Development Bank. Dubai Islamic Bank would like to seek a solution to the Sudanese operations and we currently lack clarity on the progress of the Pakistan operations. We also note that the new CEO may seek a different approach towards international expansions. f. real estate Much as we anticipated, real estate prices exhibited lower increases in 2007 relative to previous years, with selling prices increasing 19% over the year.The strength was driven primarily by a significant shortfall in the delivery of housing units, with only 11,000 units released by September compared to our full year forecasts of 27,000 (contractor and developer announced targets were c. 69,000 units). Prices were also supported by the delivery of initial phases within major developments. This highlights the importance to end-users of seeing a finished product, especially in Dubai where some developments lack a benchmark or historical precedent.
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Fig 21: Dubai Real Estate Price Index Fig 22: Dubai Real Estate Supply and Demand Forecasts
125 Dubai Real Estate Overall 80,000 Demand Supply Apartments 70,000 120 Villas 60,000 115 50,000
110 40,000
105 30,000 20,000 100 10,000
95 0 2007e 2008e 2009e 2010e 2011e 2012e Jun-07 Apr-07 Jul-07 Feb-07 Sep-07 Oct-07 Dec-06 Mar-07 Aug-07 Jan-07 Nov-07 Nov-06 May-07 Source: EFG-Hermes based on Better Homes data Source: EFG-Hermes estimates
Consequently, we have revised our forecasts for the real estate sector, taking into account the rollover of units to be delivered. This has resulted in supply lagging demand for longer, and we therefore expect the slowdown in the real estate sector to occur in 2009, versus our previous forecast of 2008. Our expectations are for an increase in real estate prices of 5-10% in 2008e and for a cumulative decrease of 15% over 2009-11e.
As an aside, it is worth highlighting that banks maintain extensive exposure to the real estate sector through several avenues: loans to construction companies, commercial and residential mortgages, associated companies involved in real estate-related activities, and direct property investments. Two banks in particular are worth noting: The first is Dubai Islamic Bank with a total exposure of AED19 billion (AED14 billion in loans, AED4 billion in real estate-related associates, and AED1 billion in direct investments), versus shareholders' equity of AED 8 billion. The second is First Gulf Bank, with AED9 billion of exposure (AED6 billion in loans and AED3 billion in direct investments), versus shareholders' equity of AED8 billion. The high gearing to the real estate sector has served these banks well during the current phase of the real estate cycle, but we would be wary of over-exposed banks once the real estate market begins to soften. g. us dollar peg As we have detailed in our Economics section, the likelihood of an AED revaluation against the USD or a move to a currency basket has increased in recent weeks.The impact on the stock market, in such an event, would come through several channels with a low but overall positive impact.
The first would be through financial statements. We see little effect on revenues overall given that the UAE is not an export-reliant economy and that the consumer sector is not well represented within the stock market. We expect to see a net easing on costs as imported materials become cheaper, wage inflation eases, and interest payments on non-AED denominated debt fall. Also, all other things being equal, companies with international operations will see the contribution from overseas earnings decrease. On the balance sheet side, again assuming that all other things remain equal, the asset values of overseas operations will fall but, at the same time, so will the value of non-AED denominated debt.
Second, investments in the UAE will become relatively more attractive as gains will be less offset by USD weakness than before. In addition, investors are likely to make arbitrage gains from any revaluation through the stock market.The most straightforward way would be to use US dollars to buy stocks in the UAE before a revaluation and sell after.
Finally, we would expect demand for real estate from foreign investors to be somewhat tempered as UAE properties become more expensive. However, this is already reflected to an extent in our forecasts, which see a 12% drop in foreign demand in 2008e. h. valuation Despite the UAE market having risen 57% this year, earnings upgrades (on the back of better than expected results in our universe) have kept overall multiples in check. The UAE trades at an attractively cheap 13.0x 2008e and 9.9x 2009e. This is comprised of Dubai trading at 12.3x 2008e, 8.2x 2009e and Abu Dhabi trading at 14.0x 2008e, 12.7x 2009e. The substantial difference between the two is driven by the lack of representation of the Abu Dhabi real estate market (which is potentially cheap on a long-term basis) and the negative investor sentiment overhang on Emaar shares.
We highlighted earlier the difference in growth prospects between financials and non-financials. It is worth noting therefore that financials trade on 14.3x 2008e and 12.9x 2009e, compared to non-financials which are on 13.6x 2008e and 9.0x 2009e.
12 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
Figure 23: EFG-Hermes Valuation Outlook 17 UAE 16 Dubai Abu Dhabi 15 14 13 12 11 10 9 8 7 2007e 2008e 2009e 2010e Source: EFG-Hermes estimates
To gauge UAE valuations in a global context, we have plotted the forward P/BV and P/E ratios (relative to ROE and earnings growth, respectively) for the banking sector against global peers. Those geographies identified with a dark green diamond are based on EFG-Hermes forecasts and the rest on Bloomberg consensus estimates. We find banks a useful proxy for the market due to the sector's dominant share in most indices and the ease of comparability.
The UAE trades more or less in line with the emerging market average on both a P/E and P/BV basis, but generates a higher ROE and lower earnings growth into next year. The UAE's relatively lower earnings growth can be attributed to a number of factors: (i) greater loan penetration compared to regional peers; (ii) the prospect of increased competition putting downward pressure on profitability; and (iii) a disproportionate impact on earnings numbers from goodwill amortization reported by Emirates NBD post the merger.
Fig 24: Global Relative Banks Valuation, Fig 25: Global Relative Banks Valuation, P/BV vs ROE 2008e P/E 2008e vs Earnings Growth 2008-09e
P/E 2008e P/BV 2008e 26 5.0 Morocco Saudi Arabia 24 India 4.5 Morocco 22 4.0 20 Saudi Arabia MENA 3.5 India HK Poland Egypt 18 HK Asia x-Jap Asia x-Jap Russia Indonesia Brazil MENA 3.0 Czech 16 Indonesia Russia Pakistan Czech UAEPoland 2.5 EM Greece 14 EM Philippines UAE Egypt Brazil Malaysia Hungary S'pore Malaysia US 2.0 Philippines Turkey 12 Pakistan Greece Lebanon Thailand Lebanon S'pore 10 Turkey 1.5 Euro UK Eurozone Hungary US Thailand S Korea 8 UK 1.0 S Korea Israel Earnings Growth 2008-09e Israel ROE 2008e 6 0.5 5% 10% 15% 20% 25% 30% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28%
Source: EFG-Hermes estimates Source: EFG-Hermes estimates, Bloomberg
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2008 bottom-up view a. summary and conclusion We believe 2008 will be a strong year for the UAE stock market, supported by a backdrop of robust earnings growth (principally in non- financials), high oil prices, abundant liquidity, and a steady real estate market.We highlight four themes which we believe will be integral in driving the stock market over the course of the year - in addition, we expect these four factors to contribute to a general increase in market volatility.
First, we anticipate the influx of Western institutions to accelerate with long only funds playing a more decisive role than in 2007. Over the course of the year, we expect this to help distribute liquidity more evenly across the stocks listed in the UAE and to draw attention to small & mid cap names that have so far been below the radar - although we expect this to be a more prominent effect in 2H2008. We expect the above to be supported by a) ongoing liberalization, resulting in more companies opening their equity bases to non-GCC investors; and b) the UAE, and the broader GCC, becoming more entrenched emerging market investment destinations. In addition, we also see Saudi retail investors re-entering the UAE stock market on the back of a gradual and sustained recovery in the Tadawul stock market.
Second, we believe IPO activity will pick up again, with privatizations and family businesses playing an important role. We expect the new listings to attract fresh liquidity and to attract names from outside the sectors that are currently dominant such as telecoms, banks, and real estate.
Third, we anticipate more focus on corporate governance reducing the information gap between listed companies and shareholders. We therefore believe that a divergence will occur between companies exhibiting good and bad corporate governance practices. Emaar, in particular, has a lot of catch up potential and its improvement in corporate governance has yet to be priced in. We expect positive newsflow next year to help reverse investor sentiment and thereby close the divergence between the Abu Dhabi and Dubai indices.
Fourth, we see a pick up in M&A activity from 2008 onwards which should provide supportive newsflow for the stocks involved. We expect consolidation to occur mostly within banks, insurance and cement; while telecoms and real estate companies are more likely to pursue regional expansion opportunities. b. stock picks We continue to believe that a combination of attractively valued blue chips, with thematic exposure to growth in the UAE, and high growth midcaps offer the best upside potential. We expect that as the year progresses, midcap ideas will gain more importance - including those that currently have limited liquidity. The earnings growth outlook and valuation multiples for our stock picks below can be found in Table 25.
The real estate sector is currently the cheapest within our coverage universe and we remain positive on Emaar, Arabtec and Union Properties. While Emaar shares suffered a substantial overhang from negative investor sentiment in 2007, we expect this to reverse out in 2008 due to the IPO of Emaar MGF and increased revenue recognition from the Burj Dubai development as well as from other international businesses. We also expect the company's improved corporate governance to be better reflected in the share price. We see significant catch-up potential in Emaar, which should help close the gap between the Dubai and Abu Dhabi indices. Arabtec is currently in a sweet spot characterized by a full pipeline for the next two years and a regional shortage of qualified contractors that should help sustain high margins. In addition, Arabtec's strategy of acquisitions should allow the company to capture revenue streams from previously unattainable sectors and geographies. Union Properties in the near term benefits from its developments in prime locations within Dubai. However, we see strong upside potential from new project announcements expected in 1H2008. Longer term, a successful diversification into motorsports, primarily through the F1 theme parks, could bring substantial additional value.
Within telecoms, we retain our preference towards Etisalat due to its compelling growth outlook, support from regional expansion- related newsflow and, finally, from the prospect of shares opening to foreign investors and local institutional investors. While no official announcements have been made, we believe that as the largest listed stock in the UAE, and with the ongoing liberalization in the sector and broader market, a change in ownership limits could transpire in 2008. While we think second operator "du" remains expensive on a P/BV basis, we believe the successful and rapid subscriber acquisition numbers will provide better support to shares going forward.
Within banks, we favor Emirates NBD and Commercial Bank of Dubai. We believe Emirates NBD will be successful in deriving both revenue and cost synergies whilst also improving cross-selling activities. Recent results indicated continued strong loan and deposit growth with a good quality balance sheet. Commercial Bank of Dubai has so far benefited from its strategy of segmenting its client base and has delivered results well ahead of our expectations. However, we believe shares have been held back due to the restriction on foreign ownership.
14 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008
In “Other”, we highlight Aramex, Air Arabia, and Tabreed. Although Aramex reported poor 3Q2007 numbers, we believe that the longer term growth story remains intact and shares are attractively priced given the very high growth forecasts. Air Arabia has managed to deliver growth ahead of our expectations and we see further upside from the purchase order for new planes and plans for a second hub. Finally, we believe Tabreed offers one of the most attractive secular growth profiles in the market with superb visibility. We believe the recent large order win from Aldar underpins the potential for the company.
While the following ideas would not form part of our core top picks, we would advise investors to keep Aabar Petroleum, RAK Ceramics, and Abu Dhabi Islamic Bank on the radar screen. While shares in Aabar have had a strong run over the year, we feel the shares are fairly valued, especially given the volatile nature of the earnings stream. However, as one of the few direct oil price plays on the stock market, we believe Aabar could continue to attract investor interest in the current high oil price environment. We believe RAK Ceramics is an excellent growth stock trading at cheap multiples. Shares have to date been held back by limited liquidity, but this could change over the year if attention on midcap stocks intensifies, as we believe it will. We see turnaround potential in Abu Dhabi Islamic Bank, where fundamentals have weakened over the year and shares has lagged the broader sector, partly due to the fact that they are closed to foreign investors. The company is currently under new management and we believe both of these factors will be addressed over 2008.
We would hold underweight positions in Dubai Investments and Amlak. While Dubai Investments has attractive growth opportunities in the UAE, and also benefits from strong liquidity, a significant proportion of earnings are derived from non-recurring sources, such as asset revaluations and gains on financial instruments. On a sum-of-the-parts basis, we believe the shares to be over-priced at current levels. The housing finance sector overall is set to experience tremendous growth due to an under-penetration of mortgage products and high population growth. However, we believe the level of return on equity does not justify the high P/BV multiple, while our expectations of future capital raising exercises serves to dilute the benefits to shareholders of the growth the company is set to experience. c. target upside We apply target P/E multiples of 16.1x 2008e and 14.0x 2009e to the UAE, giving us approximately 23-42% upside from current levels. The wide range is, for the most part, a function of the timing of real estate project deliveries. We arrive at our weighted average target multiple by applying Saudi Arabia, MENA region, and emerging market valuations to the key Banks, Telecoms and Real Estate sectors.
Table 26: UAE Target Multiple Calculation Sector Source P/E Ratios 2007e 2008e 2009e 2010e
Banks Sector Saudi Arabia EFG-Hermes estimates 20.9 18.7 16.5 n/a MENA EFG-Hermes estimates 19.3 17.4 15.5 n/a Emerging Market Consensus estimates 17.7 14.6 12.4 11.0
Telecoms Sector Saudi Arabia EFG-Hermes estimates 14.6 13.6 13.2 12.6 MENA EFG-Hermes estimates 15.4 14.1 12.5 11.0 Emerging Market Consensus estimates 18.5 15.8 13.7 12.9
Real Estate Sector Emerging Market Consensus estimates 24.7 20.5 14.8 12.6
Weighted P/E Multiples for the UAE Based on Saudi Arabia 17.5 16.1 14.9 n/a Based on MENA region 17.4 15.8 14.0 n/a Emerging Market 19.9 16.6 13.5 12.0
Target Multiple (based on median) 17.5 16.1 14.0
Current UAE Valuation 13.0 9.9 Upside / Downside 23% 42%
Source: EFG-Hermes estimates, Bloomberg
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d. upside and downside risks The primary area where we see potential for divergence from our base view regards liquidity. We could see a stronger than expected performance should Western institutional inflows be stronger than we anticipate (and vice versa). We could also see a seismic shift in Western institutional flows if the UAE were to successfully "graduate" from frontier market indices to more established emerging market benchmarks. However, we consider this to be a more likely prospect in the medium-term.
Saudi presents a double-edged sword. We would expect a recovery in Saudi Arabia to result in a spillover of value traded into the UAE. But if the Saudi market were to be opened wide to foreign investors, we could see a temporary diversion away from the UAE - indeed this could result in the Saudi market overshaddowing that of the UAE in existing frontier market indices.
Also, the failure of IPOs to come to market would be an obstacle towards generating new investment opportunities and attracting fresh liquidity.
We would regard unexpected weakness in real estate prices from our forecasts, either due to a higher rate of delivery of units or a weaker pace of immigration, to negatively affect the stock market. (Clearly the reverse also holds true). The impact would feed through both investor sentiment and corporate exposure (particularly in the banking sector) to the real estate market.
Troubles in the US credit market have so far not had a direct effect on the UAE - and we believe this will continue to be the case in 2008. However, companies that are seeking to raise funds internationally may find themselves more restricted, either due to weaker investor demand (despite excellent credit ratings) or more expensive financing terms. We highlight the recent postponement of Dubai Electricity & Water Authority's (DEWA) three-year sukuk, which cited poor market conditions as a factor.This could limit or at least slow down the acquisitive growth plans for many of the companies in the UAE.
Finally, current geopolitical tensions between the US and Iran could ultimately lead to military action. We would expect any attack against Iran to be short, targeting only suspected nuclear sites and not involving any ground forces.The immediate impact would almost certainly be negative, as panic selling (disproportionately from Western institutions) is likely to drive the stock market down. However, we would expect this to reverse as investors realize the lack of risk to the UAE. More importantly, any attack on Iran would most probably lead to a sharp increase in the oil price. This would underpin the UAE's long-term economic expansion and bolster positive sentiment towards the UAE and the other petrodollar economies in the region.
16 uae research yearbook 2008 2007: market recovery kicks in 2008: strong momentum to be maintained uae research yearbook 2008 Index Port Weight in EFG Weight Yield 4.6% 7.3%6.9% 7.7% 1.3%4.1% 4.0% 0.0% 0.6% 0.6% 2.1% 0.7% 7.6% 0.6% 1.0% 7.8% 0.8% 0.5% 1.6% 2.8% 08e 09e 07e UAEMod 5.9% 6.8% 0.3% 20.7% 19.8%13.2% 13.1% 4.2%22.4% 22.6% 1.6% 4.8%20.5% 19.4% 4.8% 1.6% 3.4% 14.9% 15.9% 2.9% 2.2% 19.2% 19.1% 1.0% 5.4% -21.1% 19.7% 3.5% 4.7% 1.4% 4.8% - - 11.5% 12.1% 6.5% 5.4% 6.4% 11.8% 12.7% 5.3% 0.0%18.8% 18.1% 2.5% 0.6% 3.1% 0.7% 0.1% 53.1% 44.7% 1.0% 0.6% 24.6% 0.2% 28.0% 3.1%11.6% 54.9% 3.3% 0.9% 13.9% 0.0% 1.2% 14.4% 2.1%34.6% 33.8% 2.3% 1.5% 19.0% 19.2% 13.1% 16.0%19.9% 28.4% 2.9%13.9% 17.4% 0.0% 0.6% 0.0% 2.1% 1.6% 2.0% - - 14.1% 19.2% 0.5% 18.2% 18.1% 2.4% 14.7% 14.9% 1.7% 24.0% 32.3% 2.8% 29.9% 32.3% 1.2% -30.2% 13.6% 0.0% 4.0% 0.9% 4.8 4.4 33.4% P/BV on Equity Return 5.1 3.5 2.5 44.9% 2.8 2.2 1.7 22.9% P/EEarnings Growth P/EEarnings 07e 08e 09e 07-08e 08-09e 07e 08e 09e 07e 19.3 17.6 11.1 9.5% 58.7% 2.9 2.5 2.1 15.0% 15.1 14.2 12.7 6.6% 11.1% 2.9 2.6 2.3 19.3% Val Trad Val Own. (AED m) Limit (AED m) (AED) 11-Dec-07 Telecommunications 22.0 18.0 15.1 22.3% 19.4% 5.8 5.4 4.9 26.3% Energy & UtilitiesEnergy Other 41.4 26.8 20.5 54.5% 30.8% 1.8 1.6 1.4 4.4% Other FinancialsConstruction Estate & Real 23.6 16.8 15.0 12.2 9.1 40.7% 5.9 12.3% 35.2% 3.6 54.6% 2.5 2.2 15.2% Banking Comm. Bank of Dubai Comm. Table 27: EFG-Hermes UAE Coverage Universe Coverage EFG-Hermes UAE 27: Table ARTC.DUEMAR.DU ArabtecUPRO.DU Emaar Union PropertiesDU.DUETEL.AD Buy / du* Buy / 5.02 Etisalat* 9.40 Buy / 5.75 10.60 13.7 14.5% 12.8% 13,968 19.7 5,621 44.3% 39.9 Buy / AIRA.DU 31.1 83,215Acc. / Acc. 23.6ARMX.DU 309.6 15% 6.10Arabia Air 49%DINV.DU Aramex 31.1 21.4 49% 7.00RKCE.AD 20.5 11.3 31.8% Dubai Investments 14.8% 117,794 3.0 6.5 11.5Ceramics RAK 24,400 5.7 / Neu. 24.8 8.5 Red. 4.3% 5.60 / Buy 35.0 Acc. 7.0 73.3% 578.5% 1.96 / Buy Acc. 0% 3.95 35.4% 15.0% Buy / -29.5% 3.20 0% 2.7 2.10 15.9 5.30 21.7% 12,156 13.9 2.4 N/M 7.1% 3.72 12.9 N/M 7.83 99.7 1.7 16.3% 2.7 18,142 82 47.7% 14.9% 2.1 12.6% 3,520 92.2 20% 1.7 2,466 7.8% N/M 24.9 10.0 23.8% 49% 0.1 9.7 5.3 N/M 49% 48.1 5.4 44.3 49% 40.4 28.7 9.9 21.8 4.1% 12.8 14.3 16.3 11.1 10.7 8.7% 80.2% -37.1% 7.3 32.2% 9.5% 2.5 33.1% 33.6% 1.9 3.6 46.6% 3.0 1.5 3.4 2.9 1.7 24.9% 3.2 2.6 1.5 7.4% 10.5% 1.3 12.1% AABAR.AD Aabar PetroleumDANA.ADTABR.DUGas Dana Acc. Tabreed / Neu. 3.88 3.75 -3.4% / Sell Neu. 2.13 3,492 / Buy Acc. 1.46 3.35 30.5 -31.5% 12,588 4.19 40% 25.1% 39.4 35.1 31.8 3,799 18.8 49% 24.9 10.3% 40.2 23.4 49% 19.4 69.1% 56.4 71.7% 1.5 40.3 35.9 1.5 20.8% 1.4 39.9% 1.7 43.6% 4.3% 1.6 1.5 3.1 1.7 4.3% 1.1 5.5% ADCB.ADADIB.AD BankComm. Abu Dhabi / Neu. Neu. CBD.DU 6.86 Abu Dhabi Islamic BankDISB.DU / Neu. Red. 63.8 6.59ENBD.DU Dubai Islamic Bank -4.0%FGB.AD 56.6 NBD Emirates 27,440 -11.2%NBAD.AD / Neu. Acc. Gulf Bank First 10.9 13.3 9,563Abu Dhabi Nat'l Bank of / Neu. Neu. 23.2AMLK.DU 30.3 11.2 Buy / 25%IAIC.DU Amlak 13.9 24.3 2.3% / Neu. Red. 13.3TAML.DU 22.7 0% 11.6 32,656 4.6% InsuranceArab Buy / Islamic 16.0 10.8 Tamweel 36,918Acc. / Acc. 10.2 15.1% 14.7 75.9 19.4 12.7 14.3% -14.6% 3.55 61,065 11.5 13.4 5.0 28,375 15% 3.62 31.5% 7.2% 16.0% 2.8 / Red. 21.8 Red. 13.4 11,464 25% 2.0% 15.7 4.92 10.8% / Neu. 2.7 Neu. 15.1 15.5 7.10 3,905 15% 5% 0.9 2.4 14.0 3.34 -14.7% 1.9 12.7 -32.1% 2.1 45.2 15.1 17.8 7.24 1.7 14.7 15.8 0% 10.4% 3.8% 13.0 13.5 7,380 20.2% 2.0% 1.5 25% 12.9 10.0% 83.8 12.2% 12.7% 7,100 3.6 2.9% 11.1 31.8 24.9 3.2 9.8 17.1% 69.5 3.6 22.2 12.8% 49% 2.9 3.0 15.9% 2.6 28.0% 30.5 15% 3.2 27.0% 2.5 22.7 2.4 13.0% 19.2 2.8 12.2% 17.2 23.0% 2.1 11.6 2.5 34.3% 10.6 2.9 3.0 14.6% 20.9% 2.5 18.2% 48.2% 2.9 2.2 2.8 3.7 9.2% 22.3% 2.6 9.5% 3.9 2.3 2.2 12.0% 1.9 22.8% RIC CodeRIC Name Company Rec Price LTFV UpsideCap M Daily Avg Foreign (institutional) investors closed to non-GCC are Highlighted shares Note: and Etisalat is closed to all institutional investors institutional investors, *du is closed to foreign EFG-Hermes estimates Source:
Fahd Iqbal Hanzada Nessim +971 4 363 4004 +971 4 363 4019 [email protected] [email protected] strategy 17 economics
growth and output
The UAE's economy has been one of the fastest growing in the world since 2003, with real GDP accelerating to 9.4% in 2006, from 8.2% in 2005, as oil output increased. The expansion has been driven by: i) strong oil export earnings, which continue to underpin the wider economy, ii) the investment drive, and iii) buoyant domestic and regional demand for the UAE's non-oil goods and services. Indeed, due mostly to Dubai's diversification program, the hydrocarbon sector now accounts directly for less than 40% of GDP. Real non-hydrocarbon growth has been averaging above 10% annually, outpacing hydrocarbon growth, which has been constrained by OPEC production agreements and lack of spare capacity. As a result of the strong economic expansion, a number of supply constraints have emerged that have caused prices to increase. The rise in inflation and the need for greater monetary control are key challenges facing the economy. The economic outlook, supported by an acceleration of Abu Dhabi's investment drive, strong demand for Dubai-based services and continued high oil prices, nevertheless remains strong through the end of the decade.
Fig 1: UAE Oil Price and Production Levels Fig 2: Contribution to Nominal GDP Growth by Emirate
(USD bn) MBD % 100 3.0 30 Abu Dhabi Dubai Other Total 90 25 Production (Right-hand Axis) 80 Murban Oil Price (Left-hand Axis) 2.8 20 70 Oil Price Year Average (Left-hand Axis) 60 15 50 2.5 10
40 5 30 2.3 0 20 10 (5) 0 2.0 (10) Jul-06 Jul-07 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jul-00 Jul-02 1998 1999 2000 2001 2002 2003 2004 2005 2006 Jul-01 Jul-03 Jul-04 Jul-05
Source: EIA, IMF, Ministry of Economy, EFG-Hermes
Real GDP growth in 2006 was wide based. Net exports (exports of goods and services minus imports of goods and services) was the main positive contributor to real GDP growth, with oil production increasing 4.4% Y-o-Y from 2.0% in 2005. Net exports contributed 4.7 percentage points to the overall real GDP growth of 9.4%, although the positive contribution was less than in 2005 as strong domestic demand pushed imports up. Nominal GDP grew 23.4%, helped by rising oil revenue:The price of Abu Dhabi Murban oil surged 22.2%, while production also increased. Real GDP growth was lower than nominal growth because the rise in the price of oil is not included in real GDP.
Fig 3: Decomposition of Nominal GDP Fig 4: Contribution to Real GDP by Demand (USD bn) % Change in Inventories Gross Fixed Capital Formation 250 Gross Fixed Capital Formation 20 Net Exports Private Consumption Government Consumption Government Consumption 15 Real GDP growth 200 Change in Inventories Private Consumption Net Exports 10 Nominal GDP Growth 150 5
100 0
(5) 50 (10)
0 (15) 2000 2001 2002 2003 2004 2005 2006 2007e 2008f 2009f 97 98 99 00 01 02 03 04 05 06 07e 08f 09f
Source: IMF, Ministry of Economy, EFG-Hermes
Domestic demand remained buoyant, driven primarily by investment, the second main contributor to real GDP growth.The contribution of gross fixed capital formation and private consumption to real GDP growth also increased in 2006. The surge in investment was originally driven by Dubai, but Abu Dhabi has been playing an increasingly important role. Indeed, in 2006, investment in Abu Dhabi soared by 36.7%, the strongest rise and the highest absolute level of investment of any of the country's emirates.
18 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
Abu Dhabi has embarked on a wide-ranging investment program, with projects worth more than USD300 billion (over 300% of estimated 2006 GDP) on-going or announced. Key investment areas include real estate, energy, industry (especially petrochemicals, plastics, aluminum, steel and glass), tourism (including cultural and sports related) and infrastructure. In Dubai, investment increased by more than 18.0%, steady from last year's increase. Investment in the other emirates, at a total 35.1%, also grew strongly, but from a markedly lower base. Nevertheless, the growth reflects the fact that other emirates are also focusing on investment and widening their economic bases in manufacturing, refining, tourism and real estate and other areas.
Fig 5: Investment by Emirate Fig 6: Investment Growth Rate by Emirate (USD bn) % Growth 350 Abu Dhabi Dubai Sharjah Other 40 Abu Dhabi Other Dubai
300 35
250 30 25 200 20 150 15 100 10 50 5
0 0 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006
Source: IMF, Ministry of Economy, EFG-Hermes
Interest rates have been strongly negative, boosting credit growth to the private sector and thus overall domestic demand (both investment and private consumption). Higher government spending and the confidence factor linked with the high oil price have also helped boost domestic demand. The continued strong influx of expatriates and an increase in private wages (averaging around 10%) in 2006 also supported private consumption, despite the sharp fall of the local stock market at the end of 2005 and the pick-up in prices, particularly rents and education.
Domestic and regional demand for UAE goods and services continued to support a number of sectors in 2006. Most non-oil activity was driven by Dubai, which acts as a regional hub in trade, financial services and other areas and which accounted for 42.0% of the UAE's total non-oil activity. The oil sector accounted for 37.3% of the UAE's GDP in 2006. A number of sectors continued to grow by double digits, including construction, manufacturing, transportation and trade, tourism, trade and the financial sector.
Table 7: Real GDP Growth by Economic Sector, % Change
Percentage Change 2001 2002 2003 2004 2005 2006
Gross Domestic Product 1.7 2.6 11.9 9.7 8.2 9.4
Crude Oil Production (incl. cond, gas) 0.0 (7.6) 13.6 2.9 1.6 6.5 Non-Oil Production 2.5 7.7 11.2 12.6 10.8 10.4 Agriculture (2.2) 0.8 0.3 9.7 6.0 5.0 Industry 1.5 7.7 11.6 13.1 9.0 14.5 Mining and Quarrying 2.9 2.3 2.8 7.0 7.0 17.0 Manufacturing 1 0.9 3.5 7.9 16.3 5.1 13.5 Electricity and Water 4.9 1.0 18.1 11.0 12.5 15.0 Construction 2.0 18.4 17.0 8.5 15.0 16.0 Services 3.5 8.2 11.8 12.6 12.1 8.7 Trade 2 1.2 17.3 17.3 17.1 16.0 9.9 Transportation, Storage, and Communication 6.1 7.1 7.8 10.1 14.0 12.0 Finance and Insurance 12.1 0.9 12.8 16.3 15.0 12.0 Real Estate 1.6 11.2 8.1 16.2 14.0 7.0
1 Includes natural gas and petroleum processing industries 2 Includes wholesale and retail; and, trade, restaurants and hotels Source: Ministry of Economy, IMF
economics 19 economics
Robust exports led by oil and increased investment caused Abu Dhabi's contribution to increase to 60.0% of nominal GDP 2006 from 57.4% in 2005. Abu Dhabi, which accounts for over 90% of UAE oil exports, is forecast to snatch an even greater share of GDP in the medium term as oil revenue remains strong and its investment drive progresses. The emirate's economy is becoming increasingly diversified, with services and tourism taking a larger share of GDP. We forecast that Abu Dhabi will increase its share of the UAE's GDP to 64% by the end of the decade.
Non-oil Sector to Drive Growth in 2007 We estimate that real GDP growth will slow to 8.6% in 2007 as oil output declines in response to OPEC production cuts. Oil production in the first 10 months of 2007 fell by 2.5% Y-o-Y. Moreover, with the continued strong growth in imports, net exports will make a negative contribution to real GDP growth, causing real GDP growth to slow. Nominal GDP growth will also decelerate as the price of oil increases more slowly than in 2006. We forecast that nominal 2007 GDP growth will slow.
The growth of investment and private consumption has continued to accelerate in 2007, with many of the factors supporting demand remaining solid or improving. Investment remains strong, especially in Abu Dhabi, where it has gained momentum. Real interest rates became even more negative after the UAE cut its rates in 2H2007, in line with the US. We believe private consumption will also grow as increased demand for labor in Abu Dhabi boosts the flow of expatriates into the UAE and now that the negative impact of the stock market crash has dissipated. Confidence in the Dubai property sector has also increased, with the long-expected fall now likely to be delayed and its magnitude attenuated. Investment and private consumption should thus be the two main contributors to real GDP growth in 2007.
We forecast that non-oil GDP growth, boosted by strong domestic demand, will accelerate to 11.2%. Construction in particular continues to benefit from the investment drive.The Dubai service sector, including trade, the financial sector and tourism, is also robust, with hotel revenue jumping by 20% Y-o-Y in the first nine months of 2007. The weakening of the USD, to which the AED is pegged, has helped make the UAE's non-oil sector more competitive.Aluminum production, which dominates manufacturing, is also forecast to jump as demand rises. government revenue and spending
Government spending continued to add a strong fiscal stimulus to the economy. UAE's strong fiscal position nevertheless continued to improve in 2006 as revenue grew faster than expenditures, thus widening the budget surplus and helping official foreign assets to build up for a fourth year. We have used IMF fiscal data and not official UAE data, which substantially understates the real strength of public finances. A significant portion of Abu Dhabi's oil earnings is directed straight to the Abu Dhabi Investment Authority (ADIA) and not reported in the accounts. The official data also excludes the substantial income generated from overseas assets. The IMF data includes the consolidated budgets of the three largest emirates, Abu Dhabi, Dubai and Sharjah, and the federal budget, which is mostly financed by Abu Dhabi. The IMF data also includes revenue and income from foreign assets. However, a number of investment projects are not captured in the budgets and would reduce the budget surplus and budget break-even points somewhat, although these would nevertheless remain strong.
Fig 8: Fiscal Balance Fig 9: Revenue Breakdown
(USD bn) Government Revenue (left-hand axis) % of GDP (USD bn) Hydrocarbon Revenue Government Balance (right-hand axis) 50 30 140 Non-Hydrocarbon Revenue 45 40 25 120 35 20 100 30 25 15 80 20 15 10 60 10 5 40 5 0 0 20 (5) (10) (5) 0 2002 2003 2004 2005 2006 2007e 2008f 2009f 2002 2003 2004 2005 2006 2008f 2009f 2007e Source: IMF, EFG-Hermes
20 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
The budget surplus widened to 28.8% of GDP in 2006 from 20.3% in 2005. Revenue increased by 48.5%, mostly because of a 50.7% rise in hydrocarbon earnings, which accounted for 76% of total revenue in 2006. Non-hydrocarbon earnings, driven largely by higher investment income, the largest source of non-oil earnings, also grew by a strong 42.1%. The buoyant economic environment and the role of Dubai as a trade hub boosted the categories of customs revenue and fees and charges. Land sales to some property developers also boosted non-hydrocarbon earnings.The budgets of the Dubai and Sharjah emirates were roughly balanced, while that of Abu Dhabi was strongly in surplus.
Expenditures have grown at a relatively constrained pace, as can be seen from the low break-even oil price for the budget.The break-even point, as calculated using IMF figures, is around USD8 per barrel lower than that based on government figures, because IMF data includes investment income and total oil revenue. Overall spending leapt 24.4% in 2006 from 10.2% in 2005 and 3.4% in 2004, thus providing a strong fiscal stimulus to the economy. Current spending, which jumped 21.5% in 2006, was driven by increased transfers and subsidies and to a lesser degree by wages and salaries.The slower growth rate in wages and salaries was due partly to Abu Dhabi's policy of reducing the size of the public sector and subcontracting work to the private sector. There was a 19.4% increase in capital expenditure that reflected higher government investment. Capital spending is forecast to accelerate going forward, especially from 2008. However, as noted, capital expenditure underestimates total developmental spending, since investments by government or entities partially owned by the government are not always included in the official budgets.We forecast that spending will be structurally higher beginning in 2006 given the development plans of Abu Dhabi, which has traditionally saved a large proportion of its additional oil income.
Fig 10: Budget Breakeven Oil Price Fig 11: Breakdown of Government Expenditure Growth
USD per Barrel % 30 30 Other Capital Expenditure 25 Total Current Expenditure 25 20 20 15 15 10
5 10 0 5 (5)
0 (10) 2002 2003 2004 2005 2006 2007e 2008f 2009f 2001 2002 2003 2004 2005 2006 2007e 2008f 2009f
Source: IMF, EFG-Hermes
The fiscal surplus is forecast to have peaked in 2006 and to have narrowed marginally in 2007. Oil revenue growth will moderate as oil production falls and the rise in the average price of oil decelerates, while expenditure growth will remain robust at around 25%. We are forecasting a fiscal surplus of 25.7% of GDP in 2007.
Consolidated government debt has increased gradually to 10.7% in 2006 from 4.7% in 2000, and it is forecast to continue increasing going forward. Abu Dhabi in July 2007 issued its first sovereign bonds, worth a total USD1 billion and maturing in August 2012. The offering, priced 18 basis points over LIBOR, was designed to establish a sovereign benchmark for corporate borrowing. Standard & Poor's assigned a rating of 'AA' senior unsecured debt rating (AA/Stable/A-1+) to the inaugural issue. Ras Al Khaimah Investment Authority (RAKIA) also issued a USD325 million, five-year Islamic bond priced 150 basis points over the three-month LIBOR to finance construction of an off-coast man-made island. There are indications that Dubai will follow with a sovereign issue in 2008.
Other debt levels are also likely to increase, although these is unlikely to be reflected in government figures. External borrowing has increased markedly (see external section) and although much of it has been classified as private sector debt, a large proportion of it is by public or part-public entities or investment funds, particularly from Dubai. The borrowing was for either funding expansion plans or purchasing overseas assets. Standard and Poor’s estimated at the end of 2007 that the level of debt raised by Dubai-based companies was equivalent to 42% Dubai’s GDP.
However, the large foreign exchange reserves held by the country's sovereign wealth funds, particularly ADIA, and the government's continued solid fiscal surpluses continue to underpin the healthy fiscal position. In July, Moody's upgraded the UAE's government bond ratings and foreign currency bank deposits to Aa2 with a stable outlook.The UAE, alongside Kuwait and Qatar, has the highest sovereign ratings in the region.
economics 21 economics
external developments
The stronger hydrocarbon revenue also widened the current account surplus to USD35.9 billion, equivalent to 22% of GDP.This was up from 18.3% in 2005 and the highest since 1990. The trade surplus, the main positive contributor to the current account surplus, increased as exports, which grew by 21.7%, outpaced imports, which grew by 15.6%. Imports were driven by strong domestic demand. On the export side, both the hydrocarbon (21.6%) and non-hydrocarbon (17.8%) sectors grew strongly.The current account surplus was further boosted by the net income account as earnings from overseas investments surged. However, in line with the strong economic activity, the deficits on net transfers and the service account widened. The deficit on net transfers was mainly the result of higher worker remittances out of the UAE. The service deficit increased, driven by higher demand for business services, despite a rise in tourism income. We forecast that the current account surplus will weaken in 2007 to 18.6% of GDP as import growth outpaces export growth. The deficit in services and transfers will continue to widen, also helping to dent the current account surplus. Fig 12: Balance of Payments Surplus Fig 13: Export and Import Growth (USD bn) (USD bn) Trade Balance Services Balance Exports Imports Trade Balance 70 Investment Income Transfers Balance 200 60 Capital Account Balance 180 50 Net Errors & Omissions 160 40 Overall Balance 30 140 20 120 10 0 100 (10) 80 (20) 60 (30) (40) 40 (50) 20 (60) 0 (70) 2001 2002 2003 2004 2005 2006 2007e 2008f 2009f 2001 2002 2003 2004 2005 2006 2007e 2008f 2009f Source: IMF, EFG-Hermes Capital Outflows Increase in Line The capital and financial account showed higher outflows as a large proportion of the country's oil earnings were invested overseas. Consequently, the overall balance of payments surplus was just 4.1% of GDP. Details of the capital account are vague. The largest outflow, however, was official capital, a reflection of the continued large build-up of foreign assets. Thus, the country's official foreign reserves increased only by USD6.6 billion, while we estimate that its foreign asset position increased by almost USD40 billion. Although the outflows overshadow other capital and financial developments, the inflow of net private capital surged, climbing 58.6% Y-o-Y in 2006 as commercial banks and the private non-bank sector increased their overseas borrowing. The net inflow of commercial banks switched to a positive USD9.7 billion in 2006 from a net outflow of USD3.4 billion in 2005. The commercial banking sector's international borrowing rose as UAE banks sought long-term funds to address an asset-liability mismatch linked to increased mortgage lending. Deposits of non-residents have also increased, spurred in part by speculation that the UAE would either change the AED's peg to the USD or revalue. Net non-bank borrowing surged by more than 100% in 2006, jumping to USD11.1 billion from USD5.1 billion. This was a result not only of private and part-public companies borrowing to expand domestically and regionally (a key tenet of Dubai's development plan), but also of sovereign wealth funds and private equity funds (particularly from Dubai) leveraging to invest overseas. The number of such organizations has recently increased, and their remits include investing in financial services, property, transportation, logistics and other sectors and expanding their geographical presence, particularly in Europe and Asia. The IMF has written that the authorities are monitoring these developments and that Dubai has indicated it will establish a debt monitoring unit.
Fig 14: Maturity of Overseas borrowing Fig 15: Sector of Overseas Borrowing (US mn) (US mn) 60,000 Up to and Including 1 year 60,000 Non-Bank Private Sector 1 to 2 years Public Sector 50,000 Over 2 years 50,000 Banks
40,000 40,000
30,000 30,000
20,000 20,000
10,000 10,000
0 0 1Q03 2Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 3Q03 Source: BIS 22 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
The liability data of the banking sector and data from the Bank for International Settlements (BIS) indicate that private sector borrowing continued to increase in 2007. The pace of overseas acquisitions by UAE investment companies also picked up in 2007. By looking at bank borrowing and other debt raised, such as sukuks (Islamic bonds) and private equity, we estimate that external debt climbed to 57% of GDP in 2007 from 18% in 2003. Given its strong external asset position, particularly Abu Dhabi's, the UAE nonetheless is comfortably a net creditor. currency developments The nominal effective exchange rate has weakened from 2003 as a result of the decline in the USD, to which the AED is pegged. The real effective exchange rate (REER) appreciated by 9.1% from 2004 to 2006, and with inflation high we forecast it will continue to strengthen in 2007. Consequently, the IMF estimates that there is no misalignment of the AED, which it says is undervalued by only around 2% with respect to its equilibrium level. Because the IMF based its analysis on official CPI data, which has tended to underestimate the true inflation level, the AED could actually be slightly overvalued. This leads us to believe that the main reason for currency reform would be to gain greater control of monetary policy rather than because the AED is undervalued. One of the main positive factors of the peg has been the USD's stability. Given the structural weakness of the USD, however, this benefit has been removed.
Fig 16: Nominal Effective Exchange Rate Fig 17: Real Effective Exchange Rate, % Increase Index: 2000=100 115 % 10.0 Kuwait Qatar Saudi UAE 110 8.0 105 6.0 4.0 100 2.0 95 0.0
90 (2.0) (4.0) 85 (6.0) (8.0) 80 (10.0) 1998-2002 2003 2004 2005 2006 Q1-01 Q3-01 Q1-02 Q3-02 Q1-03 Q3-03 Q1-04 Q3-04 Q1-05 Q3-05 Q1-06 Q3-06 Q1-07 Source: IMF
Currency reform has risen higher on the agenda in 2007, particularly in the UAE, but also in the wider GCC.This was especially the case after the US reduced interest rates in 2H2007 by a cumulative 100 basis points (bps) and after the sharp fall in the USD.These cuts put the region's central banks in a difficult position, since interest rates were were already too low given the region's strong economic activity. In the UAE, real interest rates were already strongly negative and are now even more so following the US rate cuts. Moreover, the weakening of the USD against major and emerging market currencies has added to inflationary pressure in the UAE.
The increasing importance of currency reform to UAE policy makers was reflected in statements made by the UAE central bank governor, Nasser al-Suweidi, in November. Al-Suweidi said that the while the USD peg had served the country well, the currency regime was now at a "crossroads", given the weakening of the USD and the likelihood it would fall further. The governor said the UAE might look at pegging the AED to a basket of currencies, consisting mostly of the USD. These comments were followed by a number of top UAE officials highlighting the need to move the AED away from its peg to the USD. Al-Suweidi had previously made strong comments about the USD peg that were not followed by a change to the currency regime, yet this was nevertheless the strongest indication so far that the UAE is looking to move away from the USD peg. We believe there will be some form of currency reform in 1H2008. At the end of 2007, the UAE was still committed to moving in unison with the wider GCC; otherwise, it could have already de-pegged from the USD. If GCC countries decide to continue coordinating their policies, then there could be a small revaluation of their currencies of 3% to 5% against the USD. A lack of a consensus, however, could lead the UAE (followed by Qatar) to move independently to a currency basket. A key factor as to when the GCC together or the UAE alone moves would be if the USD were to weaken further in the last weeks of 2007 and in early 2008 or if the Fed were to cut interest rates aggressively. We now believe that the likelihood of a move in 1H2008 by the UAE (either with the wider GCC or independently) is more than 60%. Given the increasing prominence of the non-oil sector and the UAE's economic diversification plans, any move toward currency reform will be gradual.The UAE does not want the non-oil sector to lose competitiveness. At the same time, due to the pick-up in inflation, the effective exchange rate has actually appreciated, meaning that the AED is not as markedly undervalued as has been suggested. Finally, the overseas investment of oil revenue also reduces pressure for currency appreciation. If the AED were to be linked to a basket of currencies, we forecast an initial move again of 3% to 5%, followed by gradual moves depending on USD developments. There is also the possibility of a stronger move of approximately 10%. This would help to kill speculation of further AED appreciation, while also counterbalancing some of the impact of the USD decline (such as higher import costs and reduced value of remittances sent overseas).
economics 23 economics
We believe that a currency basket rather than a one-off revaluation would be more beneficial in the longer term. A revaluation would generate speculation of further AED appreciation at times of USD weakness, without providing flexibility on monetary policy. In contrast, a trade-weighted basket would enable the UAE to counterbalance any USD weakness (as Kuwait does with its gradual appreciations against the USD) or any subsequent USD strengthening (with the UAE lowering the AED to keep the international competitiveness of its economy from deteriorating). inflation and monetary developments inflation Annual average inflation surged to 9.3% in 2006 from 6.3% in 2005, according to official data. We believe the 2006 figure is more realistic than earlier figures, although it still underestimates the true level of price rises. We estimate that the true inflation figure was closer to 14%. Inflation in 2006 as measured by official figures nevertheless reached a record high. The official figure underestimates inflation partly because it measures different spending patterns and gives different weights to the CPI basket.The official weighting tends to reflect the spending habits of the national population, which is in the minority and does not face the same increases in housing, education and health care costs that expatriates face. As in previous years, housing in 2006 was the main driver of inflation, with costs increasing 15.3% as the population rose faster than housing supply.We estimate that rental prices, which are the main outlay of most expatriates, in Dubai increased by 30% in 2006, albeit down from the increase of 40% the previous year. Demand from the growing expatriate population is also pushing up education and health costs. The weakening of the USD also helped push up the cost of imported goods, especially food. Strongly negative real interest rates and an expansionary fiscal stance have also added to the upward inflationary pressure. Fig 18: Consumer Price Index Fig 19: Credit Growth to the Private Sector % CPI, % %, Y-o-Y 45 10 Other 10 9 Housing 9 40 Food and Tobacco 8 CPI 8 35 7 7 30 6 6 25 5 5 20 4 4 15 3 3 10 2 2 5 1 1 0 0 0 2004 2006 2001 2002 2003 2005 2008f 2009f 2007e Jan-05 Jan-02 Sep-02 Jan-04 Sep-04 Sep-05 Jan-06 Sep-06 May-01 May-02 May-03 May-04 May-05 May-06 May-07 Jan-01 Sep-01 Jan-07 Jan-03 Sep-03 Source: UAE Central Bank, IMF and EFG-Hermes
We forecast only a modest Y-o-Y fall in UAE inflation in 2007. Based on the official figures and weightings, we forecast inflation of 8.7% in 2007 and 7.6% in 2008. Dubai's inflation growth rate is likely to slow as the increase in rental prices moderates to 16% (which is nevertheless above the 7% rent cap) in 2007. Rental prices are expected to contract marginally in 2008, when new housing is due to come on the market.Abu Dhabi, on the other hand, has begun facing increasing upward inflationary pressure as it gears up its investment drive, which will keep the overall UAE inflation rate high. In Abu Dhabi, housing will again be the main driver, given the influx of expatriate labor and the consequent housing shortage, which has already been driving up rents. Abu Dhabi's housing shortage is expected to continue until 2010 as population growth outpaces the supply of residential units. Inflation in Abu Dhabi rose to 8.3% in 2006 from 3% in 2002. Abu Dhabi's consumer price index (CPI) rose by 11.3% Y-o-Y in 1H2007, according to official figures. The rent and fuel component surged 32.3%, contributing 7.2 percentage points to the total 11.3% increase.
Continued weakening of the USD and strong liquidity in banking system will limit the fall in the inflation level. Even if the UAE moves away from the USD peg to a more flexible currency regime and tightens monetary policy, inflation will fall only marginally, given the continued housing shortage.
Although in a high inflationary environment there is always a risk that higher wage expectations will cause inflation to become entrenched, we believe the risk of this happening in the UAE, where expatriates make up around 90% of the workforce, is relatively low. Expatriate wages have risen 10-15% on average and even more in a number of labor-short sectors, such as construction and financial services. It should be relatively easy to slow down wage increases once inflation and the competition for labor fall. To counterbalance inflation, the government is slated to increase the salaries of federal workers by 70% in 2008. The federal budget, however, accounts for less than 20% of total government expenditure in the UAE, with the bulk occurring at the level of individual emirates. We forecast that these emirates will also increase wage expenditure, not only to counterbalance inflation, but also to reflect continuing high oil prices.
24 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
interest rates The UAE's interest rate policy is determined by the AED's peg to the USD, an arrangement that requires domestic interest rates to track US rates. The earlier US rate hikes in 2006 were positive for the UAE, given its strong economic activity, highly liquid banking sector and credit growth, and allowed the central bank to increase benchmark rates. Interest rates nevertheless needed to rise even higher, and in real terms remained negative. To tighten monetary policy, the central bank in 2007 began increasing the value of its certificates of deposits (CDs).
Following US rates cuts in September and October, however, the UAE Central Bank in September and November reduced its CD rates, which are used to which determine interbank rates, but by a lesser extent.This was due to the strong liquidity in the UAE banking system and the negative interest rates.
At the end of November 2007, the central bank replaced its system of daily sales of fixed-rate CDs with a series of CD auctions. This was positive in that it increased the monetary tools available to the central bank. The new arrangement for the first time allows repurchase agreements (the rate at which the central bank lends to commercial banks). The central bank set its first overnight repurchase rate at 4.75%, which raised the cost of borrowing: It was 25 bps higher than the Fed Fund rate in the US and higher than the 4.5% CD rate under the fixed system. In its first auction, the one-week CD rate fell to 4.2% from 4.4% the previous week, when the CDs were sold under the fixed-rate system, while the one-year rate slid to 4.05% from 4.15%. Rates were expected to fall further given the high liquidity in the banking system and the demand for government paper.
The UAE responded to a 25 bps cut in US interest rates in December by reducing its repo rate by 25 bps to 4.25%. This followed a cumulative 25 bps cut in the repo rate in the previous week, thus bringing it in line the US Fed Fund Target Rate (FFTG). Although the cumulative 50 bps cuts was probably also an attempt to reduce speculation, we believe that the UAE central bank had the flexibility to keep the repo rate higher than the FFTR, given that it is the central bank's lending rate to commercial banks. However, the effectiveness of the repo rate is diminished by the strong liquidity in the banking system and thus the reduced need for commercial banks to borrow from the central bank. Nevertheless, the introduction of the repo rate increases the monetary tools available for the central bank going forward. The repo rate will increasing be used as the benchmark rate.
In another positive step, the maturity of the longest-dated CD was extended to five years from the previous 18 months. This was an important step in developing the capital market and an AED yield curve. Once developed, the yield curve will be a useful benchmark for local corporate borrowing. An increase in domestic borrowing and reduced dependence on foreign borrowing is important if the UAE should decide to peg the AED to a basket of currencies instead of solely to the USD. The UAE central bank will also auction CDs denominated in USDs and EURs in what could be a sign of the increasing role of the EUR in the UAE economy and its possible introduction in a future currency basket.
Fig 20: Interest Rate Movements Fig 21: Credit Growth to the Private Sector % % % Other 8 Weighted Average Lending Rate 3M Deposit Rate 8 60 Interest Rate Spread 28 Day CD Rate Personal Loans Trade 7 7 50 Construction 6 Total 6 40 5 5 30 4 4 20 3 3 10 2 2 0 1 1
0 0 (10) 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Feb-04 Feb-05 Feb-06 Feb-07 Oct-03 Oct-04 Oct-05 Oct-06 Source: UAE Central Bank, IMF and EFG-Hermes money supply Money supply (M2) growth has remained strong, although it moderated somewhat in 2006, when it grew by 23.2% Y-o-Y, down from 30.5% the previous year. In 1H2007, however, M2 again accelerated to 34.3% Y-o-Y. The growth in domestic liquidity continues to be driven by the accumulation of net foreign assets by the central bank (although in 2006 net foreign assets contracted as external liabilities increased), along with continued credit growth to the private sector. In 2006, credit growth was driven largely by personal loans as demand for funds to invest in IPOs increased. In 1H2007, however, it was driven largely by construction lending and by personal loans for business, mainly in real estate; government borrowing increased by 44% Y-o-Y, albeit from a very low base.
economics 25 economics
The loan-to-deposit ratio of the banking sector increased in 2006. The trend was reversed in 1H2007, when credit growth slowed and deposit growth remained strong. AED deposits grew especially fast in 2Q2007, when speculation grew that the AED would be revalued against the USD. meduim-term macroeconomic outlook gdp growth outlook The short- to medium-term growth outlook for the UAE remains strong. We forecast that real GDP will grow in the high single digits until the end of the decade. Real GDP growth is forecast to accelerate to 9.0% in 2008 as UAE oil production increases.The nominal growth rate will also benefit from an increase in the oil price, although the increase will not be as fast as that seen from 2003 to 2006. We forecast real GDP growth of 8.2% in 2009 owing to the strong base effect and to limited spare capacity in both the oil and non-oil sectors.
With oil prices high, government spending growth will remain strong (above 20%), supporting private confidence in the economy. Investment will be an important economic driver until the end of the decade and beyond, with Abu Dhabi playing an increasingly important role given the size of its investments and the fact they are still at an early stage. Total awarded and planned investments in the UAE as a whole as of November stood at USD592.1 billion. With only 20% of planned projects in the UAE having begun, the number of new project starts is due to increase in 2008. Although Dubai is further along in its investment drive, a number of mega projects, such as Dubai Waterfront, Dubai Industrial City, Dubai World Central, Palm Deira and some projects in Dubailand, are still at an early stage of development. The growing size of the expatriate population needed to support this investment drive and to service the wider region, the country's negative interest rates and its robust consumer confidence will ensure that private consumption remains strong. With buoyant domestic and regional demand, the non- oil sector growth will remain strong. Dubai has become a service and trade hub for the wider region, and services and trade-related industries will continue to benefit from the boom in the GCC.The non-oil sector will have real growth of around 9% to 11% until the end of the decade.
The main risk to the outlook is further constraints on the supply of materials and skilled and unskilled labor that could increase the cost of projects and slow their completion. In addition, contractors and sub-contractors are also in short supply. Although these supply constraints may slow the levels of investment and delay projects, the investment program itself will continue. Other risks to the economic outlook are a sharp decline in the oil price and geopolitical tensions in the wider region, especially those linked to Iran. A military strike on Iran would have mixed consequences. The oil price would spike in such an event, causing oil earnings and the nominal GDP growth rate to increase. However, the non-oil sector, especially tourism, which accounts for around 18% of Dubai's GDP, would see a sharp downturn. The negative impact of any strike on Iran would be short term and limited once it is seen that the UAE is otherwise not impacted.
Meduim-Term Macroeconomic Outlook Actual MT Projections Macroeconomic Indicators 2002 2003 2004 2005 2006 2007e 2008F 2009F Real Sector Average Brent Crude Spot Price (USD/B) 25.0 28.8 38.3 54.5 65.4 70.5 73.1 67.5 GDP at Current Market Prices (AED bn) 276.5 325.3 381.1 488.4 599.7 635.3 711.5 732.1 GDP at Current Market Prices (USD bn) 75.3 88.6 103.9 133.1 163.4 173.1 199.9 213.5 Real GDP Growth Rate, % 2.6 11.9 9.7 8.2 9.4 8.6 9.0 8.2 Population (mn) 3.4 3.6 3.8 4.1 4.4 4.7 5.2 5.7 GDP /Capita (USD) 22,158 24,622 27,330 32,461 37,138 36,830 38,436 37,448 CPI Inflation (YoY % Change) 2.9 3.2 5.0 6.3 9.3 8.7 7.6 7.2 External Sector Trade Balance (USD billion) 15.0 21.4 26.8 42.7 56.5 53.2 55.7 52.4 Current Account Balance (USD bn) 3.7 7.6 10.2 24.3 35.9 32.1 32.7 28.6 Current Account, % of GDP 4.9 8.6 9.8 18.3 22.0 18.6 16.3 13.4 Net Foreign Assets (USD bn) 35.4 36.3 40.4 44.3 41.4 47.5 54.2 59.7 Fiscal Sector Budget Balance (USD bn) 1/ (2.0) 2.3 10.9 27.0 47.0 44.5 46.0 42.1 Budget Balance/GDP (2.6) 2.6 10.5 20.3 28.8 25.7 23.0 19.7 Net Banking Sector Claims on the Govenrment (SAR bn) (32.6) (30.2) (31.8) (47.3) (51.7) (62.6) (70.5) (80.4) Financial Sector USD/AED Exchange Rate, End of Period 3.67 3.67 3.67 3.67 3.67 3.67 3.49 3.38 Annual Growth Rate in Broad Money, % 11.0 15.5 23.8 30.5 23.2 35.6 31.0 29.7 Growth in Credit to the Private Sector, % 11.4 13.4 24.0 41.8 32.9 31.4 30.4 27.6 3M Deposit Rate, End ofPeriod, % 1.0 0.7 1.5 3.7 5.3 3.0 3.2 3.5
Source: UAE Central Bank, Ministry of Economy, IMF and EFG-Hermes 26 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
fiscal outlook The fiscal surplus will remain strong at 23.0% of GDP in 2008 and 19.7% of GDP in 2009, albeit down from 2007, as spending increases more robustly than revenue. Oil revenue will continue to increase in 2008, with higher oil prices and production levels. Oil revenue is forecast to fall as oil prices and production soften somewhat in 2009 from their high levels. Non-oil revenue growth will remain strong, although investment income in 2008 is likely to be dampened by turmoil in global markets linked to the sub-prime and credit crises.
We forecast that consolidated spending will increase by more than 20% in 2008 and in 2009. Spending will be broad-based, with both current and capital expenditure expanding strongly. Increases in wages and salaries in particular will cause current expenditure to rise. Wage spending has not kept up with other areas of spending: Federal wages have remained stagnant for the last few years, while Abu Dhabi and Dubai have also kept their wages under control. Federal wages are slated to increase by 70% in 2008. We forecast that wage expenditure will also increase on an emirate basis, owing to inflation but also to reflect the continued high oil price. Spending in the 2008 federal budget is set to increase by 24% to AED34.9 billion as spending jumps in other areas as well. The budget outlay for public health, for example, will increase by 66%. The federal budget accounts for less than 20% of total government expenditure in the UAE, with the individual emirates accounting for the bulk of spending. external outlook Although export growth will slow, oil prices will remain relatively robust, helping to ensure that the UAE maintains a strong current account surplus over the outlook period. Stronger import growth will cause the trade surplus to narrow. Recycling surplus oil revenue into overseas investments will cause the large capital account deficit to persist over the two-year forecast period. Still, it will be smaller than the current account surplus, keeping the balance of payments position in surplus. In addition, the capital account deficit reflects the government's policy of foreign asset acquisition and is in line with the current account surplus: As such, it is a positive rather than a negative risk factor.
The most important development on the external front is likely to be a shift in the currency regime. We are forecasting a more than 60% probability that the UAE in 1H2008 moves either to revalue the AED in tandem with the wider GCC or to link the AED independently to a basket of currencies. If it revalues the AED, we believe it will do so in the magnitude of 3% to 5%. If it links the AED to a basket of currencies, we forecast an initial move again of 3% to 5% followed by gradual changes depending on USD developments. In our outlook table, we are forecasting an appreciation of 5% against the USD in 2008 and a 3% appreciation in 2009. inflation and monetary outlook The UAE's inflation rate will moderate in 2008 and 2009, due largely to falling rental prices in Dubai, especially in 2009. We forecast an inflation rate of 7.6% in 2008 and 7.2% in 2009. A revaluation of the AED against the USD or moves to a currency basket will also help to limit imported inflation to a degree. The extent of the decline in inflation, however, will be limited by rental inflation in Abu Dhabi.
Domestic liquidity and credit growth will also remain strong.The monetary environment will remain expansionary over the outlook period, with real interest rates set to stay negative. Linking the currency to a basket of currencies would have the advantage of providing greater monetary policy flexibility, although interest rates would be unlikely to move markedly from USD interest rates, as the USD would continue to dominate any currency basket. A mere revaluation against the USD would result in periodic strong inflows as speculators shift funds into the AED in the belief the currency will appreciate further. An increase in monetary tools would help the UAE authorities set policy more to the needs of the domestic economy: A move to a currency basket would allow a greater interest rate differential with US interest rates.
economics 27 economics
long term population outlook
The objective of this outlook is to establish long-term UAE population projections for the research team to use in its analyses.A population outlook is crucial when examining banking, real estate, telecommunications and other sectors. population developments, 2001 to 2006 The UAE's population, in line with its booming economy, surged by a 2001-2005 CAGR of 6.5%. Much of the population growth was in Dubai, where, driven by its investment program and its widening economic base, the number of inhabitants grew by a CAGR of over 8%. Sharjah, at over 7%, also grew strongly, although this was mostly spillover from Dubai owing to the latter's supply constraints and rising rental costs.The population growth was driven predominantly by an influx of expatriates, although the growth of the national population is also estimated to have been strong. UAE nationals account for only 20.1% of the population, according to preliminary data from the 2005 census.
Fig 1: UAE Population by Emirate Fig 2: Weighted Population Growth by Emirate (mn) % Abu Dhabi Dubai Sharjah Other Abu Dhabi Dubai Sharjah Other Total 5.0 10 4.5 9 4.0 8 3.5 7 3.0 6 2.5 5 2.0 4 1.5 3 1.0 2 0.5 1 0.0 0 2001 2002 2003 2004 2005 2002 2003 2004 2005 2006* 2006* *Preliminary (The data for 2006 is preliminary. The population estimates for 2006 look too low given the level of economic activity and the rent rises in both Dubai and Abu Dhabi. We have estimated higher population growth rates for 2006 in our population projection analysis.) Source: Ministry of Economy
Driven by an influx of expatriates, the UAE's workforce grew by a strong CAGR of 8.1% between 2001-06. As expected, the growth has been strongest in areas that are a focus of economic activity, most notably Dubai. The construction sector, at a CAGR of 16.2%, had the highest growth, and by 2006 accounted for 22.8% of the total workforce, up from 15.8% in 2001.The increase in the number of workers in real estate and business services (8.24%), restaurants and hotels (8.1%) and the financial sector (8.0%) was also robust. population growth rate to accelerate, 2007-11 We forecast that population growth will accelerate to a 2007-12 CAGR of 9.1%, with the UAE's total population rising to 6.7 million in 2012 from 4.1 million in 2005.The national population will continue to grow rapidly, by an estimated 3.2% per year until the end of the decade before accelerating to 3.5% until 2020. The main growth driver will nonetheless be an increased inflow of expatriates. This acceleration will be fueled in particular by Abu Dhabi as it implements its investment and development plans. These plans focus to a large extent on real estate and construction, but are nevertheless broad-based and also include oil and gas, infrastructure, industry and tourism. The initial focus in all these areas will be on construction and therefore in the beginning they will tend to attract construction workers.The inflow of professionals linked with the development program will also accelerate, especially in 2008 and 2009, and is already reflected in the strong pick-up in rental inflation owing to housing shortages, which will be the main driver of inflation in 2008 and 2009.
Dubai will also support population growth, although not to the same extent as Abu Dhabi. Dubai is further along in its investment drive and many of its projects have been completed or are close to completion. Still, a number of large-scale projects are at their early stages and will continue to underpin demand for construction workers. Moreover, high oil prices and strong GCC economic performance will ensure that the flow of professionals into Dubai remains strong until the end of the decade. After 2010, however, the growth rate for both construction workers and professionals will moderate as the marginal demand for workers falls. This will result in the UAE's overall population growth rate starting to slow. The number of expatriates in the other emirates, although starting from a much lower base point and with substantially lower growth rates, will also increase owing to their investment programs.
28 uae research yearbook 2008 2007: demand driven growth 2008: outlook remains strong uae research yearbook 2008
Fig 3: Population Breakdown Fig 4: Number of Construction Workers by Emirate Population (mn ) Expatriate Construction Worker 1.8 Construction Workers - Other Emirates 8.0 Expatriate Other Construction Workers - Dubai Expatriate 0ther Worker 1.6 Construction Workers - Abu Dhabi 7.0 National Population Total 1.4 6.0 1.2 5.0 1.0 4.0 0.8 3.0 0.6 2.0 0.4 1.0 0.2 0.0 0.0 2007f 2008f 2009f 2010f 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018e 2019f 2020f 2006e 2006e 2007f 2008f 2009f 2010f 2011f 2012f 2013f 2014f 2015f 2016f 2017f 2018f 2019f 2020f Source: EFG-Hermes population growth normalizes as projects end, 2012 to 2020 The UAE's population growth rate is forecast to moderate to between 2012-2020 as large-scale projects wind down in Dubai and the other emirates. We forecast a population CAGR of 2.5%. The completion of projects in Dubai will cause the number of construction workers to fall sharply, contracting by 48.0% between 2012 and 2016. The number of construction workers in the other emirates will fall by 55.2% as their projects are also completed. We forecast that the influx of non-construction expatriates to Dubai will stabilize at a growth rate of around 3.0% over this period.
Abu Dhabi will absorb some of the construction workers flowing out of Dubai, although the growth rate of its construction workers is forecast also to stabilize as its investment drive becomes more established. The influx of non-construction workers will be boosted at the beginning of the 2012-20 period as projects such as tourist developments are completed and demand new types of labor in Abu Dhabi. We forecast that from 2015, the influx of non-construction workers will begin to stabilize.
Given that Abu Dhabi embarked on its investment program later than Dubai, we forecast a sharp contraction in construction workers only at the end of the decade, between 2018 and 2019, as the overall investment drive winds down. We forecast that by 2020 the percentage of construction workers in the overall UAE workforce will fall to 12%, and that the total population will reach 7.9 million.
Monica Malik +971 4 364 1902 [email protected] economics 29 banking sector
2007 year in review consolidation, mergers and acquisitions The most interesting event for UAE banks in 2007 was the merger of Emirates Bank International and National Bank of Dubai to form Emirates NBD, a merger that had been long in the coming. We believe the decision was driven by a desire to strengthen the domestic banking sector in the face of falling barriers to international competition driven by free trade agreements (FTAs) and cross-border licensing agreements.
The merger created the biggest bank in the Middle East by assets and the biggest in the UAE on most other measures. Compared to Asian competitors ICICI or DBS, however, the bank is still small, and measured against many of the international players participating in the UAE banking system, of course, it is tiny. Nevertheless, with a starting market capitalization in excess of AED40 billion, it is a bank with sufficient scale to have strong operations in every banking segment, including corporate banking, retail banking, investment banking, private banking, wealth management and Islamic banking.
While this was by far the most important merger and acquisition event, it was not the only one: EIIC acquired a controlling stake in ADIB via a convertible bond. While it initially seemed to be a soft takeover, ADIB's undershooting of results on a quarterly basis seems to have led EIIC to make several changes to its senior management.
Following on from these two events, the market spent much of the rest of the year tossing back and forth other merger possibilities, both domestic and cross-border. Nevertheless, none of these looked particularly likely as it was never clear who would or should be the controlling management team in the event of a takeover. Furthermore, given the impossibility of a slash-and-burn Anglo-Saxon-style takeover, any acquisition would have to weigh rather more on revenue synergies than on the cost synergies usual in developed markets. Consequently the only two other acquisitions were both small and cross-border: Commercial Bank of Qatar agreed to acquire a 40% stake in Sharjah-based United Arab Bank, and ADIB bought a controlling stake in Egypt's National Bank for Development, which had a large portfolio of non-performing loans.
Despite the general theme of consolidation and the UAE's undoubtedly over-banked environment, the central bank also gave permission for two new banks to open in the UAE, taking the total at the end of the year to 49. Both of the new banks were Islamic, capitalized at around USD1 billion and wholly government-owned: Al Noor Bank, by Dubai, and Al Hilal Bank, by Abu Dhabi.This increased the number of UAE-based Islamic banks to seven. financial performance in 2007 While there were dramatic developments on the corporate action side, operationally things were more prosaic. Growth continued to cool from the heady days of 2005. The central bank suggested annualized Q-o-Q growth rates of 24% in both 1Q2007 and 2Q2007, although for the banks in our coverage we now expect weighted loan growth for the year of 38%, ranging from 16% (ADIB) to 82% (FGB).
Fig 1: Total Credit Growth Fig 2: Loan Growth by Bank 117% 120% 2005a 2006a 60% 100% 2007e 50% 80% 40% 30% 60% 20% 40% 10% 0% 20%
-10% 0% -20% DIB FGB CBD ADIB ADCB NBAD System 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 Emirates NBD
Source: UAE Central Bank bulletins Source: Annual reports, EFG-Hermes
We had also forecast a pick up in competition, driven by the then-imminent FTA, and expectations of slowing loan growth into an overcapitalized situation. While there was some evidence of competitive pressure, we had forecast that this would mostly impact pricing, and in the event it was more the banks responding to the expectation of competitive pressure that never arrived.
30 uae research yearbook 2008 2007: too many banks, too few banks? 2008: bottom line growth solid uae research yearbook 2008
Consequently, instead of spreads shrinking, and thereby reducing cost-to-income ratios, they were stable. At the same time, surging costs directly caused cost-to income ratios to rise. Indeed, spreads actually widened at many banks as a result of a mix effect from having more of the balance sheet allocated to higher spread items.
Fig 3: Av. Spreads for Our Coverage Universe Fig 4: Total Costs for Our Coverage Universe (AED million)
2.5% 2000
2.3% 1800
2.1% 1600
1.9% 1400
1.7% 1200
1.5% 1000 4Q06 2Q07 1Q06 3Q07 2Q06 4Q07 3Q06 1Q07 FY2004 3Q2007 1Q2005 2Q2005 3Q2005 4Q2005 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 4Q2007
Source: Annual reports, EFG-Hermes Source: Annual reports, EFG-Hermes 2008 outlook
While in 2007 we were anxious to illustrate that core growth was strong in spite of the collapse in 2H2006 of volatile sources of income, 2008 will be about steady progression. Loan growth held up better than expected for our universe of seven banks in 2007. We expect the seven to continue to take a disproportionate share of loan and deposit growth, though with indebtedness levels rising we expect some slowing of growth. There has also been significant talk of 2008 being a major year for project finance. While this is certainly a possibility, we do not necessarily believe that the banks would be best served by jumping in with their balance sheet, and so diverting funds from areas where spreads are wide and competition low to an area where competition is high and spreads are low.
We believe in general that 2008 will be a year where the banks focus not only on maintaining good balance sheet growth, but also increasingly on improving the quality of that balance sheet growth. In particular we highlight that banks looking for exposure to mortgages and SMEs exhibited successful high profitability growth at the tail end of 2007.
Consequently, although we expect some pressure on spreads, this will to a large extent be offset by the mix effect as most banks continue to head down the path of increasing exposure to the retail segment - either through general retail banking or increased mortgage lending - and for other banks through raising their exposure to the smaller corporates.
Fig 5: Spreads Fig 6: Non-interest Income as % of Revenue
4% 2007e 70% 2006a 2008e 2007e 60% 2008e 3% 50%
40% 2% 30%
1% 20% 10%
0% 0% DIB DIB FGB FGB CBD CBD ADIB ADIB ADCB ADCB ENBD ENBD NBAD NBAD Sector Sector
Source: Annual reports, EFG-Hermes Source: Annual reports, EFG-Hermes
banking sector 31 banking sector
Non-interest income saw a relative decline in 2007 due to the absence of stock-market-related gains. In some cases the same can be said of the property market in 2008: Banks that show the biggest dip in non-interest income as a proportion of earnings will be those that received the strongest benefit from property-related earnings in 2007. With few signs that the property market is stabilizing at the moment, however, the shift will be from supernormal profitability to high profitability, and we expect continued reductions of the profitability of the property portfolios going into 2009.
The influence of the markets is also likely to be fairly neutral going into 2008, instead of the strongly negative influence going into 2007. The market had been lackluster throughout 1H2007, but picked up strongly in terms of value and trading volumes in 3Q2007. Many banks obtain fee income from market-related activity, such as brokerage and fund management, and some continue to have significant balance sheet exposure to the markets.
Fig 7: Breakdown of Non-Interest Income Fig 8: DFM and ADSM F&C Trading 10,000 160 ADSM (rebased) Market Property & Other 150 DFM (rebased) 8,000 140
6,000 130 120 4,000 110 100 2,000 90 0 80 2007e 2008e 2005a 2006a 11-Jul-07 11-May-07 11-Jun-07 11-Jan-07 11-Mar-07 11-Apr-07 11-Feb-07 11-Sep-07 11-Nov-07 11-Oct-07 11-Dec-06 11-Dec-07 11-Aug-07
Source: Annual reports, EFG Hermes Source: Zawya
Cost growth has been led by inflation, expansion of physical infrastructure, product infill and staff increases. These costs will continue to increase. However, the negative surprise in 2007 was also partially driven by transitional expense such as investment in IT and systems, and we expect this to ease back significantly during 2008. For some banks where investment cost had been an unusually large part of the cost base, 3Q2007 results already suggest that overall costs were down Q-o-Q. On a system-wide basis, however, we do not expect this to be the case going forward, particularly as the effect of delayed inflation of property leases is going to have a negative effect. Consequently, while costs will continue to rise, the rate of rise will be more in line with underlying revenue growth.
While provisioning has been relatively dormant over the last couple of years, in 3Q2007 nearly every bank had a surprising pick-up in provisioning. This was a little surprising given that coverage ratios are generally thought to have reached target levels, implying that provisioning should ease. Many of the banks commented that provisioning picked up after management decided to take a more conservative view on loan quality. Nevertheless, there is the possibility either that write backs are beginning to decrease their positive influence or that non-performing loans are on the rise. For the system as a whole we don't expect a big pick-up in provisioning in 2008, although we do think that as asset inflation decreases and banks extend riskier credit we are likely to see a significant increase over the medium term.
Fig 9: Cost-to-income Ratio Fig 10: Provisioning
50% 2006a 0.6% 2006a 2007e 2007e 45% 2008e 0.5% 2008e 40% 0.4% 35% 0.3% 30% 0.2% 25%
20% 0.1%
15% 0.0% DIB DIB FGB CBD FGB CBD ADIB ADIB ADCB ENBD NBAD ADCB ENBD NBAD System System
Source: Annual reports, EFG-Hermes Source: Annual reports, EFG-Hermes
32 uae research yearbook 2008 2007: too many banks, too few banks? 2008: bottom line growth solid uae research yearbook 2008
risks Risks stemming from global market turbulence are limited, we believe, primarily because the UAE is a country with net surplus liquidity, in spite of its enormous projects. Consequently, it is highly unlikely that there could be a systemic issue. Given the absence of a local treasury market, many of the banks conduct significant amounts of their treasury management business through US and international treasuries, and in principle the possibility exists that this will lead to problems. However, given that the major banks have given us assurance that the bond investments are either in AA or better linked securities, this should not be a problem.The sole exception to this is ADCB, which marked down credit losses on their US collateralized debt obligation (CDO) exposure to the tune of AED240 million in 3Q2007. While we do not yet have confirmation that the positions are closed, we believe that it would have used the opportunity to kitchen sink relevant losses during the change of CFO, and away from year-end results. Otherwise, given the absence of detailed disclosure at the 3Q2007 stage, it is still possible we will face negative news at the FY2007 stage, but we believe it is unlikely, at least for the majors.
Foreign exchange revaluation is more complex to evaluate. Our economists have forecast a large probability of a small devaluation as soon as 1H2008. Not only that, but if the AED were allowed to fluctuate against the USD, there is the probability that this would in turn mean higher interest rates. In terms of translational exposure, only NBAD drives a substantial portion of its business through overseas operations. However, in practice it is likely that the trade finance business, meaning primarily letters of credit and letters of guarantee, would also be affected.
The second impact of an appreciating currency would be felt on the balance sheet, which would be affected both by the appreciating currency and by rising interest rates. The 2006 annual reports generally show a net long position, except for the two components of Emirates NBD, which both show a net short position. Nevertheless, this position is relatively small, with only DIB, and to a lesser extent FGB, being affected in a meaningful manner - although it should also be mentioned that NBAD does not report foreign currency exposure. Furthermore, with a potential appreciation well-flagged, it seems likely that the more exposed banks will have taken steps to mitigate their exposure, and any losses that do occur will likely be taken directly to equity and not through the income statement.
Impact of 10% FX Appreciation Assuming 2006 FX Exposure is Unchanged.
Fig 11: as a % of Market Capitalization Fig 12: as a % of 2008 Earnings 7% 100% 6% 80% 5% 4% 60%
3% 40% 2% 20% 1% 0% 0% -1% -20% -2% -3% -40% ADCB ADIB CBD DIB ENBD FGB NBAD ADCB ADIB CBD DIB ENBD FGB NBAD
Source: Annual reports, EFG-Hermes Source: Annual reports
Should interest rates rise, the main thing we might be concerned about would be a substantial maturity mismatch. However, as there is relatively little long-term lending, and there is in some cases substantial short term borrowing, the interest rate mismatch is likely to be relatively minor, and further given that any mismatch is likely to be hedged, we do not believe there is likely to be a problem. Indeed, an interest rate increase would likely to lead to higher net interest income, all other things being equal. conclusion While the problems that afflict banks are generally speaking the unexpected ones, rather than the expected ones, we believe that the banks in the UAE are well placed to go into 2008 relatively free from the concerns that afflict the international sector. Furthermore, unburdened with the higher level of volatile market-related income that we have seen in previous years, with a few exceptions we believe that steady growth can be maintained.
Raj Madha, CFA +971 4 363 4009 banking sector [email protected] 33 national bank of abu dhabi (nbad)
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Neutral Current Price: AED 23.2 Balance Sheet LT Rec. Neutral LT Fair Value : AED 24.3 Cash 7,761 20,834 24,123 24,422 Due from Banks 22,268 8,677 10,206 11,432 Net Loans (Conventional & Islamic) 57,486 77,164 92,782 103,923 Other Interest Earning Assets 10,935 12,190 12,312 12,435 Tradeable Assets & Associates - - - - Stock Data Property and Equipment 424 466 513 564 Last Ex-Div Date AED0.40 on 13 Mar 2007 Other Assets 2,092 2,712 3,201 3,531 Mkt Value (Local mn) AED 36,918 Total Assets 100,966 122,044 143,138 156,308 Shares (mn) 1,591 Customer Deposits 70,738 73,567 88,281 97,109 Av. Mthly Liquidity (mn) AED123.8 Due to Banks 6,069 16,185 15,891 16,509 Medium Term Notes & Other CM Funding 12,032 17,928 21,806 22,776 52-Week High / Low AED24.30 / 14.62 Other Financial Liabilities - - - - Bloomberg / Reuters NBAD UH / NBAD.AD Other Operating Liabilities 3,611 3,974 4,694 5,204 Est. Free Float 27.0% Total Liabilities 92,450 111,655 130,671 141,597 Shareholders' Equity 8,516 10,389 12,467 14,711 Minority Interest - - - - Total Liabilities & Equity 100,966 122,044 143,138 156,308 Income Statement Net Interest Income 2,021 2,337 2,732 3,131 Net Commission Income 519.4 571.8 628.9 691.8 Brokerage & Fund Management 237.4 249.2 274.2 301.6 (AED) 2006a 2007e 2008e 2009e Income from Investments & Associates 138.7 275.5 303.1 333.4 EPS 1.32 1.50 1.66 1.82 Property Income - - - - EPS Growth -18.4% 13.5% 10.4% 10.0% Other 39.4 37.7 41.5 45.7 P/E17.6 15.5 14.0 12.7 Total Non-interest Income 934.9 1,134 1,248 1,372 Total Banking Income 2,956 3,471 3,980 4,504 General & Administrative Expenses (703.6) (978.1) (1,195) (1,337) DPS 0.31 0.32 0.35 0.41 Provisions for Customer Loans (101.0) (42.1) (80.1) (192.2) Dividend Yield 1.3% 1.4% 1.5% 1.8% Provisions for other losses 2.0 - - - Income before Taxes & Minority Interest 2,153 2,451 2,705 2,974 BVPS 5.35 6.53 7.83 9.24 Tax & Zakat (51.0) (63.8) (70.4) (77.5) Net Income before Minority Interest 2,102 2,387 2,634 2,897 P/BV 4.34 3.55 2.96 2.51 Minority Interest - - - - Mkt Cap / Loans 64.2% 47.8% 39.8% 35.5% Net Income 2,102 2,387 2,634 2,897 Ratios Growth in Net Loans 11.7% 34.2% 20.2% 12.0% Growth in Deposits 18.7% 4.0% 20.0% 10.0% Loans / Deposits 81.3% 104.9% 105.1% 107.0% Growth in Net Interest Income 20.5% 15.6% 16.9% 14.6% 26 Growth in Operating Expenses 12.1% 39.0% 22.1% 11.9% 24 Growth in Provisions Made -34.7% -58.3% 90.0% 140.0% Growth in Net Income 21.8% 13.8% 10.4% 10.0% 22 Net Interest Spread 0.95% 1.63% 1.70% 1.70% 20 Net Interest Margin 2.05% 2.06% 2.12% 2.15% 18 Non-interest Income / Revenue 31.6% 32.7% 31.4% 30.5% 16 Cost / Income 23.8% 28.2% 30.0% 29.7% Provisions Made / Average Gross Loans 0.16% 0.06% 0.09% 0.20% 14 Net Loans / Assets 56.9% 63.2% 64.8% 66.5% 12 Customer Deposits / Liabilities + SHF 70.1% 60.3% 61.7% 62.1% 10 Capital Adequacy Ratio 17.8% 17.2% 17.1% 17.7% Growth in NPLs 1.4% 203.1% -57.5% 20.7% NPLs / Gross Loans 1.6% 3.6% 1.3% 1.4% NPL Coverage Ratio 96.7% 32.6% 77.0% 70.9% 11-May-07 11-Dec-06 11-Jan-07 11-Feb-07 11-Mar-07 11-Apr-07 11-Jun-07 11-Jul-07 11-Aug-07 11-Sep-07 11-Oct-07 11-Nov-07 11-Dec-07 RoAE27.2% 25.2% 23.1% 21.3% RoAA 2.3% 2.1% 2.0% 1.9% Prices as at 11 December 2007 Source: NBAD, EFG-Hermes estimates
Raj Madha, CFA 34 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: steady progress 2008: balanced growth uae research yearbook 2008
background National Bank of Abu Dhabi, the second largest bank in the UAE by market capitalization, has operations in Egypt, Oman, Kuwait and other financial centers. NBAD has more than 100 branches, with at least 75 in the UAE, 20 in Egypt, four in Oman and one in each in London, Paris, Switzerland, Sudan, Washington D.C. and Bahrain. It is 73% indirectly owned by the government of Abu Dhabi, while foreign investors are limited to a combined stake of no more than 25%. NBAD has the largest deposit base in the UAE and enjoys a strong position in personal and corporate lending, investment banking, treasury, bancassurance and wealth management. It is primarily known, however, as a corporate bank. 2007 - regional expansion
NBAD for some years has been the most conservative of the banks that we cover, preferring not to target the SME sector aggressively or to offer mortgage loans until after the product and market have been rigorously tested. However, in some ways things are changing, with NBAD looking to expand its presence at least geographically. This year it launched its Swiss Private Banking operation to serve primarily Gulf investors out of Switzerland. NBAD plans to continue to develop a corporate and a high-net-worth banking network in Egypt and in Oman. In terms of product expansion, it has set up a new Islamic finance window, although it is not clear whether this has actually become operational yet.
Balance sheet growth accelerated after a relatively slow 2006. Deposit growth was strong throughout most of 2007, but loan growth lagged, boosting liquidity.This abruptly reversed in 3Q2007, when loan growth accelerated sharply and deposits lagged. Overall, for 2007 we now expect loan growth of 34%, substantially in line with market growth rates of 38%. These better drivers of net interest income, however, were offset by weaker fees and commissions and, as with most of the rest of the sector, higher costs. Consequently, while the make-up of the income statement has changed slightly, our net income expectations for the year are substantially unchanged from a year ago. 2008 - gaining ground
Strategically, the target for the year is to get the existing expansion projects running smoothly, in particular the Swiss Private Bank and the branch rollout. Islamic financing, while not really a feature of 2007 results, is likely to begin driving volumes in 2008, although it can be a little more difficult to turn those volumes into profitability. In addition, NBAD has mentioned that it needs to segment the corporate and business banking book, and this may have a visible impact in 2008.
NBAD is also on the acquisition trail, and never put as much effort into denying a possible alliance with ADCB as ADCB itself did. Now that ADCB is beginning to look a little less solid, and NBAD's stock is rising a little higher, this might not be as difficult an alliance as it seemed during 2007. Furthermore, it is likely that NBAD will be looking at other opportunities to supplement organic growth.
There are concerns that NBAD, which has the largest foreign branch network of the UAE banks, could be vulnerable to any adjustment of the UAE currency. While it is possible that it has the relevant hedges in place, it is likely that these would cover the balance sheet and not the income statement. Nevertheless, our economics team expects a revaluation of only 5%, and it is likely that the impact of this would be of the order of 1% of net income. recommendation NBAD is the most expensive conventional bank in our UAE universe, based on 2007e price-to-book, in part justified by its superior return on equity. In spite of lower growth rates, NBAD trades at a premium to the sector with less chance of efficiency improvements. Overall, we estimate a LTFV of AED24.28, suggesting 5% upside, and have a ST/LT Neutral recommendation.
banking sector | nbad 35 abu dhabi commercial bank (adcb)
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Neutral Current Price: AED 6.86 Balance Sheet LT Rec. Neutral LT Fair Value : AED 6.59 Cash 1,898 7,062 6,587 7,175 Due from Banks 10,065 13,381 13,173 13,137 Net Loans (Conventional & Islamic) 62,425 74,338 87,823 101,056 Other Interest Earning Assets 3,701 4,071 5,089 5,852 Tradeable Assets & Associates 1,076 2,152 2,807 3,228 Stock Data Property and Equipment 512 563 620 682 Last Ex-Div Date AED0.303 on 29 Mar 2007 Other Assets 1,411 2,340 2,433 2,873 Mkt Value (Local mn) AED27,440 Total Assets 81,088 103,908 118,530 134,002 Shares (mn) 4,000 Customer Deposits 43,397 56,416 66,571 76,556 Av. Mthly Liquidity (mn) AED294.9 Due to Banks 7,970 6,821 8,049 9,256 Medium Term Notes & Other CM Funding 16,610 23,930 25,430 27,430 52-Week High/Low AED7.80 / 5.30 Other Financial Liabilities 806 1,912 2,494 2,868 Bloomberg/Reuters ADCB UH / ADCB.AD Other Operating Liabilities 2,791 4,541 4,465 4,987 Est. Free Float 35.0% Total Liabilities 71,574 93,621 107,009 121,098 Shareholders' Equity 9,448 10,204 11,429 12,800 Minority Interest 66 83 93 104 Total Liabilities & Equity 81,088 103,908 118,530 134,002 Income Statement Net Interest Income 1,774 2,266 2,675 2,890 Net Commission Income 1,129 864 907 1,043 (AED) 2006a 2007e 2008e 2009e Brokerage & Fund Management - - - - Income from Investments & Associates 157.0 88.1 96.8 106.5 EPS 0.52 0.52 0.59 0.63 Property Income - - - - EPS Growth 6.8% -0.6% 14.3% 7.2% Other 36.9 29.9 64.4 72.5 P/E13.2 13.3 11.6 10.8 Total Non-Interest Income 1,323 981.5 1,068 1,222 Total Banking Income 3,097 3,247 3,743 4,111 DPS 0.30 0.29 0.28 0.29 General & Administrative Expenses (758.6) (928.0) (1,085) (1,241) Dividend Yield 4.4% 4.2% 4.1% 4.2% Provisions for Customer Loans (193.5) (158.5) (188.5) (222.4) Provisions for Other Losses - - - - Income before Taxes & Minority Interest 2,145 2,161 2,470 2,648 BVPS 2.36 2.55 2.86 3.20 Tax & Zakat (2.6) (3.5) (4.0) (4.3) P/BV 2.91 2.68 2.40 2.14 Net Income before Minority Interest 2,142 2,157 2,466 2,643 Minority Interest (65.6) (92.0) (105.1) (112.7) Mkt Cap / Loans 44.0% 36.9% 31.2% 27.2% Net Income 2,077 2,065 2,361 2,531 Ratios Growth in Net Loans 48.1% 19.1% 18.1% 15.1% Growth in Deposits 27.9% 30.0% 18.0% 15.0% Loans / Deposits 143.8% 131.8% 131.9% 132.0% Growth in Net Interest Income 29.2% 27.7% 18.1% 8.0% 8.0 Growth in Non-Interest Income 3.6% -25.8% 8.8% 14.4% 7.5 Growth in Operating Expenses 46.6% 22.3% 16.9% 14.5% Growth in Provisions Made -8.9% -18.1% 18.9% 18.0% 7.0 Growth in Net Income 11.7% 0.7% 14.3% 7.2% Net Interest Spread 2.08% 2.00% 1.89% 1.89% 6.5 Net Interest Margin 2.65% 2.53% 2.48% 2.41% Non-interest income / Revenues 42.7% 30.2% 28.5% 29.7% 6.0 Cost / Income 24.5% 28.6% 29.0% 30.2% Provisions Made / Average Gross Loans 0.38% 0.23% 0.23% 0.24% 5.5 Net Loans / Assets 77.0% 71.5% 74.1% 75.4% Customer Deposits / Liabilities + SHF 53.5% 54.3% 56.2% 57.1% 5.0 Capital Adequacy Ratio 16.3% 13.4% 12.6% 12.3% Growth in NPLs 18.8% 15.9% 14.6% 15.1% NPLs / Gross Loans 1.8% 1.7% 1.7% 1.7% 11-Apr-07 11-Jun-07 11-Sep-07 11-Jan-07 11-Jul-07 NPL Coverage Ratio 88.4% 81.0% 76.4% 72.8% 11-Aug-07 11-Feb-07 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-Dec-06 11-May-07 RoAE23.0% 21.0% 21.8% 20.9% RoAA 3.0% 2.2% 2.1% 2.0% Prices as at 11 December 2007 Source: ADCB, EFG-Hermes estimates
Raj Madha, CFA 36 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: uncertain road 2008: building a new path uae research yearbook 2008
background Abu Dhabi Commercial Bank is the sixth largest bank in the UAE by market cap, making it the smallest of the top tier. ADCB has two divisions, a commercial banking division, active in both retail and corporate banking, and a smaller investment banking division. ADCB is also particularly strong in infrastructure projects, most notably through three consolidated 51%-owned joint ventures with Macquarie Bank of Australia. Government entities own 65% of ADCB, while foreign investors are allowed to own a maximum of 25% of the bank. ADCB has 39 branches across the UAE focused primarily in Abu Dhabi and Al Ain, although it also has a sizeable presence in Dubai. ADCB maintains two branches in India, although their contribution to profits is negligible. 2007 - unanswered questions
This was an interesting year for ADCB. 2007 started brightly with positive balance sheet surprises and strong net interest income prompting upward revisions to forecasts. However, the positive surprise in 1Q2007 did not carry through into 2Q2007, which was hit by weak deposit growth and a big jump in costs. However, it was developments in the third quarter which posed the questions.
The most salient feature of 3Q2007 results was the AED240 million hit to the CDO and treasury portfolio from US exposure, of which AED70 million was booked through the income statement and the remainder directly to equity. While this might be thought of as merely unlucky, it also suggests ADCB was benefitting from favorable pricing on what seemed like a low-risk treasury portfolio. In other ways, however, 3Q2007 results also strongly surprised in a positive way. This included a massive jump in spreads of 58 basis points, and a jump in fees and commissions. These positive unexplained surprises were partially offset with a big increase in minority deductions, suggesting that the Macquarie Bank joint ventures accounted for significantly higher profits in 3Q2007.
Overall could this be a positive? It really depends on the answer to the obvious questions raised. One possibility is that ADCB has booked profits, so as to be able to offset the AED70 million of losses taken through the income statement. Alternatively, if the positive surprises relate to significantly higher recurring profits in the joint ventures, then the picture is one of improved underlying profitability. Certainly both scenarios are compatible with the information that has been released to date. 2008 - greater clarity
With the picture going into 2008 so obscure, it is unsurprising that the picture in 2008 is also quite obscure. For the moment we assume all of the unexplained gains and losses are not recurring. Nevertheless, the underlying picture is not particularly flattering, with loan growth half the rate of the other banks, and for the first time in a while falling below that of NBAD, while on deposit growth it is no better than average. In spite of these concerns, we forecast steady symmetric balance sheet growth driving good net interest income, feeding through ultimately to about 14% earnings growth.
The CDO exposure was mostly revalued downwards at the end of 3Q2007 rather than booked as a trading loss, indicating that the position had not been liquidated. Since CDO pain has continued since the end of 3Q2007, we would expect further losses in this portfolio in 4Q2007. recommendation ADCB is the cheapest investible bank based on our 2007 PE estimates. Furthermore, on a price-to-book ratio it is significantly the cheapest bank in Abu Dhabi. Nevertheless, with key questions for the moment left unanswered, our recommendation on the stock is qualified. We have a ST/LT Neutral recommendation on ADCB, with an estimated FV of AED6.59, indicating 4% downside.
banking sector | adcb 37 first gulf bank (fgb)
December year end (AED mn) 2006a 2007e 2008e 2009e ST Rec. Neutral Current Price: AED 22.7 Balance Sheet LT Rec. Neutral LT Fair Value : AED 19.4 Cash 4,172 2,741 3,817 4,572 Due from Banks 12,212 1,371 2,863 3,429 Net Loans (Conventional & Islamic) 25,161 45,691 63,621 76,208 Other Interest Earning Assets 3,891 12,452 9,961 10,061 Tradeable Assets & Associates 1,619 4,249 4,674 5,039 Stock Data Property and Equipment 334 385 424 466 Last Ex-Div Date AED0.70 on 28 Feb 2007 Other Assets 371 1,289 1,093 1,744 Mkt Value (Local mn) AED 28,375 Total Assets 47,759 68,178 86,453 101,518 Shares (mn) 1,250 Customer Deposits 34,434 48,208 62,671 73,951 Av. Mthly Liquidity (mn) AED636.9 Due to Banks 297 5,303 6,894 8,135 52-Week High/Low AED22.70 / 11.10 Medium Term Notes & Other CM Funding 3,398 3,755 4,755 5,755 Other Financial Liabilities Bloomberg/Reuters FGB UH / FGB.AD ---- Other Operating Liabilities 1,519 1,909 2,051 2,284 Est. Free Float 35.0% Total Liabilities 39,649 59,175 76,370 90,125 Shareholders' Equity 8,110 9,003 10,083 11,394 Minority Interest - - - - Total Liabilities & Equity 47,759 68,178 86,453 101,518 Income Statement Net Interest Income 962.5 1,298 1,645 1,928 Net Commission Income 239.0 474.5 593.2 682.1 Brokerage & Fund Management 34.5 1.4 1.7 2.0 Income from Investments & Associates 96.4 241.3 291.2 331.7 (AED mn) 2006a 2007e 2008e 2009e Property Income 177.3 544.7 293.0 322.3 EPS 1.20 1.50 1.55 1.74 Other 558.3 63.1 78.9 90.7 EPS Growth 33.9% 25.4% 2.9% 12.8% Total Non-interest Income 1,106 1,325 1,258 1,429 P/E19.0 15.1 14.7 13.0 Total Banking Income 2,068 2,623 2,903 3,357 General & Administrative Expenses (438.7) (559.4) (693.5) (823.8) DPS 0.70 0.79 0.68 0.69 Provisions for Customer Loans (132.0) (185.7) (277.6) (354.0) Provisions for other losses - - - - Dividend Yield 3.1% 3.5% 3.0% 3.1% Income before Taxes & Minority Interest 1,497 1,878 1,932 2,179 BVPS 6.49 7.20 8.07 9.11 Tax & Zakat - - - - Net Income before Minority Interest 1,497 1,878 1,932 2,179 P/BV 3.50 3.15 2.81 2.49 Minority Interest - - - - Mkt Cap / Loans 112.8% 62.1% 44.6% 37.2% Net Income 1,497 1,878 1,932 2,179 Ratios Growth in Net Loans 85.0% 81.6% 39.2% 19.8% Growth in Deposits 98.9% 40.0% 30.0% 18.0% Loans / Deposits 73.1% 94.8% 101.5% 103.1% Growth in Net Interest Income 84.6% 34.9% 26.7% 17.2% 25 Growth in Non-interest Income 31.6% 19.9% -5.1% 13.6% 23 Growth in Operating Expenses 76.0% 27.5% 24.0% 18.8% Growth in Provisions Made 7.4% 40.7% 49.5% 27.5% 21 Growth in Net Income 51.3% 25.4% 2.9% 12.8% 19 Net Interest Spread 1.81% 1.95% 1.90% 1.85% 17 Net Interest Margin 2.13% 2.49% 2.32% 2.21% Non-interest income / Revenues 53.5% 50.5% 43.3% 42.6% 15 Cost / Income 21.2% 21.3% 23.9% 24.5% 13 Provisions Made / Average Gross Loans 0.48% 0.53% 0.51% 0.51% Net Loans / Assets 52.7% 67.0% 73.6% 75.1% 11 Customer Deposits / Liabilities + SHF 72.1% 70.7% 72.5% 72.8% 9 Capital Adequacy Ratio 21.3% 14.6% 12.7% 12.1% Growth in NPLs 5.1% 74.3% 34.0% 19.8% NPLs / Gross Loans 1.4% 1.4% 1.3% 1.3% NPL Coverage Ratio 129.6% 90.6% 88.4% 95.7% 11-Dec-06 11-Jan-07 11-Feb-07 11-Mar-07 11-Apr-07 11-May-07 11-Jun-07 11-Jul-07 11-Aug-07 11-Sep-07 11-Oct-07 11-Nov-07 11-Dec-07 RoAE19.1% 21.9% 20.2% 20.3% RoAA 4.0% 3.2% 2.5% 2.3%
Prices as at 11 December 2007 Source: FGB, EFG-Hermes estimates
Raj Madha, CFA 38 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: above market growth 2008: increasingly about real estate uae research yearbook 2008
background With steady outperformance, First Gulf Bank has overtaken ADCB as Abu Dhabi's second and the UAE's fifth largest bank by market capitalization. Nevertheless, it operates through only 16 branches with a geographical bias towards Abu Dhabi, but otherwise evenly spread. The ruling family of Abu Dhabi took direct control of the bank in the late 1990s, building its stake up to 61%, with the government also holding a stake. The current core shareholders brought in new management and began to restructure the bank using Citibank as a model. At first mostly a corporate bank, FGB has now expanded into retail and investment banking and treasury, and latterly has significant property exposure, both directly and through associates. Foreign shareholders are limited to a combined 15% stake. 2007 - normalized earnings up only 16%, but of higher quality
FGB has continued to maintain its differential with the market, growing its balance sheet at double the rate of the system as a whole. In previous years, the main driver has been corporate banking, but this year its retail banking division reached maturity. Indeed, we now expect the retail division to make a greater contribution to profits than the corporate division. The only disappointments this year have been a lack of progress on international expansion and the slower-than-expected impact of the housing committee loan scheme.
This year, FGB also steadily increased its exposure to the property sector. In particular, it now has three 40%-owned associates engaged in various aspects of the property market: Aseel Finance (an Islamically compliant financing and investment company), Green Emirates Real Estate Company and Inshaa Properties (property development and management). It also has a substantial property portfolio on its balance sheet that it increased to AED2,943 million as of end-September from AED533 million at the beginning of 2007. 2008 - market share gains continue, property developments
Going forward, FGB retains the ability to maintain growth above market levels in the near future, enabling it to gain market share over the next couple of years, we believe. It has made its gains to date despite having relatively little mortgage or SME exposure. Nevertheless, with many businesses reaching maturity, we believe market share gains are likely to be harder to come by in the future. Further out, therefore, we believe that it will be increasingly hard to maintain the differential.
Property exposure is becoming ever more important, to the point where we now regard it as a core recurring source of income. Nevertheless, going forward, we do not think the level of returns (revaluation returns) are sustainable even in the current buoyant property market. As the property market cools, we are concerned that property-related revenues may diminish. FGB's associates are driven as much by volumes as prices, so this may compensate, but any lack of near instantaneous revaluations is likely to weigh on profit growth in 2008 and beyond. It is also possible that, like many of the other banks, FGB will choose to spin off its property portfolio at some point next year. recommendation Non-recurring earnings leave the 15.1x 2007e P/E looking reasonable, although on 2008e multiples of 14.7x FGB is currently the most expensive of the conventional banks.We do like the operation and expect the bank to continue to take market share, although we expect this to be more difficult going forward as the UAE's retail business matures.The bank has strong returns on equity, in spite of having the highest levels of capital adequacy, suggesting the underlying differential is larger. Overall, assuming a couple more years of market share gains, we find the price up to speed with events, and estimate a LT Fair Value of AED19.39, indicating 15% downside. Based on this, we have a ST/LT Neutral recommendation.
banking sector | fgb 39 emirates nbd (enbd)
December year end (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 13.9 LT Rec. Buy LT Fair Value : AED 16.3 Balance Sheet Cash 9,907 17,582 20,176 23,159 Due from Banks 10,376 16,738 16,463 18,898 Net Loans (Conventional & Islamic) 109,055 153,120 177,082 203,688 Other Interest Earning Assets 24,663 30,829 38,537 44,317 Stock Data Tradeable Assets & Associates 6,493 6,974 7,544 8,165 Last Ex-Div Date N/A Property and Equipment 812 1,056 1,161 1,277 Mkt Value (Local mn) AED61,065 Other Assets 10,532 10,831 10,720 11,087 Total Assets 171,838 237,132 271,683 310,591 Shares (mn) 4,393 Customer Deposits 95,341 142,969 172,300 198,536 Av. Mthly Liquidity (mn) AED173.7 Due to Banks 30,618 38,922 39,874 47,653 52-Week High/Low AED 6.00 / 8.50 Medium Term Notes & Other CM Funding 18,826 23,368 23,368 23,368 Bloomberg/Reuters ENBD UH / ENBD.DFM Other Financial Liabilities 2,075 3,579 4,107 4,701 Est. Free Float 44.0% Other Operating Liabilities 3,570 5,101 5,943 6,851 Total Liabilities 150,430 213,940 245,592 281,108 Shareholders' Equity 21,407 22,905 25,768 29,118 Minority Interest 2 287 323 365 Total Liabilities & Equity 171,838 237,132 271,683 310,591 Income Statement Net Interest Income 2,695 3,988 5,065 5,794 Net Commission Income 980.7 1,176.8 1,353 1,556 Brokerage & Fund Management 122.3 103.9 119.5 137.5 Income from Investments & Associates 623.0 595.7 722.0 796.8 (AED) 2006a 2007e 2008e 2009e Property Income 78.3 17.8 93.8 51.6 EPS 0.68 0.81 0.99 1.16 Other 558.6 743.3 890.3 1,060 EPS Growth 5.8% 19.2% 22.4% 16.7% Total Non-interest Income 2,363 2,638 3,179 3,602 P/E20.4 17.1 14.0 12.0 Total Banking Income 5,058 6,626 8,244 9,396 General & Administrative Expenses (1,830) (2,546) (3,077) (3,450) DPS 0.28 0.32 0.34 0.40 Provisions for Customer Loans (215.9) (466.3) (639.9) (735.9) Dividend Yield 2.0% 2.3% 2.5% 2.8% Provisions for other losses (25.6) (52.2) (166.9) (122.7) Income before Taxes & Minority Interest 2,986 3,561 4,360 5,088 Tax & Zakat - - - - BVPS 4.87 5.21 5.87 6.63 Net Income before Minority Interest 2,986 3,561 4,360 5,088 P/BV 2.85 2.67 2.37 2.10 Minority Interest (0) - - - Mkt Cap / Loans 56.0% 39.9% 34.5% 30.0% Net Income 2,986 3,561 4,360 5,088 Ratios Growth in Net Loans 58.2% 40.4% 15.6% 15.0% Growth in Deposits 43.2% 50.0% 20.5% 15.2% Loans / Deposits 114.4% 107.1% 102.8% 102.6% 17 Growth in Non-interest Income 41.0% 11.6% 20.5% 13.3% Growth in Operating Expenses 39.0% 39.1% 20.9% 12.1% 15 Growth in Provisions Made 226.1% 115.9% 37.2% 15.0% Growth in Net Income 20.3% 19.2% 22.4% 16.7% Net Interest Spread 1.62% 1.90% 1.89% 1.85% 13 Net Interest Margin 2.10% 2.15% 2.15% 2.14% Non-interest income / Revenues 46.7% 39.8% 38.6% 38.3% 11 Cost / Income 36.2% 38.4% 37.3% 36.7% Provisions Made / Average Gross Loans 0.24% 0.36% 0.39% 0.39% 9 Net Loans / Assets 63.5% 64.6% 65.2% 65.6% Customer Deposits / Liabilities + SHF 55.5% 60.3% 63.4% 63.9% Capital Adequacy Ratio 15.5% 13.1% 12.5% 12.7% 7 Growth in NPLs 6.6% -100.0% -- NPLs / Gross Loans 0.8% 0.0% 0.0% 0.0% NPL Coverage Ratio ---- 11-Oct-07 11-Dec-07 11-Mar-07 RoAE17.7% 16.1% 17.9% 18.5% 11-Feb-07 11-Jan-07 11-Jun-07 11-Nov-07 11-Dec-06 11-Apr-07 11-May-07 11-Jul-07 11-Aug-07 11-Sep-07 RoAA 2.1% 1.7% 1.7% 1.7% Prices as at 11 December 2007 Source: ENBD, EFG-Hermes estimates
Raj Madha, CFA 40 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: new born 2008: testing its mettle uae research yearbook 2008
background Although the merger between Emirates Bank International and National Bank of Dubai was announced in March 2007, the new entity Emirates NBD took until October before it actually took effect. By total assets, Emirates NBD is now the largest bank in the GCC and has strong positions in every major banking area, including retail banking, mortgages, premium banking, private banking, Islamic banking, corporate banking and investment banking.
Emirates NBD operates through three major branch networks, those of National Bank of Dubai, Emirates Bank's meBANK and Emirates Islamic Bank.The branches cover primarily Dubai, but with a significant presence, particularly for Emirates Islamic Bank, in Sharjah.With less than 10 of its 109 UAE branches in Abu Dhabi, Emirates NBD is significantly underexposed to that market. Emirates NBD is 56% owned by the Dubai government, while the rest is open to the public, of which 5% is available for GCC or foreign investors. Major investments include a 48.9% stake in Union Properties, with a market capitalization of AED13.8 billion. 2007 - consolidation story, but no growth hiatus
After the announcement of the merger in March 2007, the market needed to hear four things: i) that minority investors would be protected, ii) that management and cultural issues would be resolved rapidly, iii) that there was plan for extracting the merger benefits, and iv) that the cost of the merger, in terms of investment as well as management distraction, would not be excessive.
Compared to a developed world bank, it had some advantages, chiefly that both banks had straightforward IT systems with fairly new database management systems and relatively few records kept on customers, making the data integration a much simpler process. In addition, management uncertainty was resolved rapidly with the announcement of the key members of staff early in the acquisition process.To us, at least, the exchange ratio seemed fair, reflecting the fact that most of the synergies should accrue to NBD shareholders. 2008 - time to deliver
Emirates NBD have forecast strong revenue synergies of AED195 million (equivalent to 10.5% of NBD revenues), and cost synergies of AED151 million (equivalent to 22.2% of NBD costs). In the July merger document, the timing of these synergies was expected to be one-third each in 2008, 2009, and 2010. So far progress on integration has been, as far as an outsider can tell, fairly limited. Some products are being cross-sold from one franchise to another, and there has been a degree of co-branding. Furthermore the ATM systems have already been integrated. Now, however, is the time to deliver. We would like to see over the coming few months a much more detailed integration strategy, spelling out in particular plans for the branch network. Not only do we need to see the plans, however, we also need to see some of them executed. We currently believe that the bank has been aggressive with its targeted synergies, and would like to see some justification before any further upgrades.
Meanwhile, progress for the individual entities seems to be gathering steam even without the more tangible operating synergies we have mentioned. We expect the strong results of 2007 will continue into 2008. In particular, we expect solid balance sheet growth and evenly balanced non-interest growth. The big question though is whether Emirates NBD is ready for the next strategic step. With much talk of an "intra-regional merger", and stronger stock, a further acquisition is a possibility, but one maybe better left until the current merger has been seen through. recommendation With its current 2007 PE ratio of 17.1x, Emirates NBD is the most expensive stock in our universe. Nevertheless, with its above-average cost base, scope for improved efficiency exists even before the synergies that we would expect from 2008. In fact, Emirates NBD is the UAE's cheapest conventional bank on its 2007 price-to-book ratio of 2.85x, while revenue synergies should suggest that it will be at least within the pack in terms of revenue growth. Momentum is strongly behind the results, suggesting that the stock should trade at a premium.With our sole hesitation its potentially acquisitive strategy going forward, we therefore recommend a ST/LT Buy, with upside of 15% to the current share price of AED13.90.
banking sector | enbd 41 commercial bank of dubai (cbd)
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 10.2 Balance Sheet LT Rec. Buy LT Fair Value : AED 13.4 Cash 3,227 3,448 4,013 4,661 Due from Banks 665 580 753 902 Net Loans (Conventional & Islamic) 12,643 19,331 25,084 30,072 Other Interest Earning Assets 1,055 1,583 1,978 2,275 Tradeable Assets & Associates - - - - Stock Data Property and Equipment 382 420 462 508 Last Ex-Div Date AED0.45 on 04 Mar 2007 Other Assets 734 808 979 1,233 Mkt Value (Local mn) AED11,464 Total Assets 18,705 26,170 33,270 39,651 Shares (mn) 1,130 Customer Deposits 13,756 18,295 23,701 28,441 Av. Mthly Liquidity (mn) AED32.4 Due to Banks 336 2,195 3,081 3,697 52-Week High/Low AED10.20 / 6.30 Medium Term Notes & Other CM Funding - - - - Bloomberg/Reuters CBD UH / CBD.DU Other Financial Liabilities - - - - Other Operating Liabilities 1,280 1,680 1,889 2,362 Est. Free Float 80.0% Total Liabilities 15,372 22,171 28,670 34,500 Shareholders' Equity 3,333 3,999 4,599 5,151 Minority Interest - - - - Total Liabilities & Equity 18,705 26,170 33,270 39,651 Income Statement Net Interest Income 625.9 872.9 1,132 1,354 Net Commission Income 192.4 237.7 261.5 313.8 Brokerage & Fund Management 22.1 20.0 23.0 26.5 (AED) 2006a 2007e 2008e 2009e Income from Investments & Associates 54.7 150.7 136.1 149.7 Property Income - - - - EPS 0.53 0.79 0.91 1.03 Other 6.2 11.7 12.9 14.2 EPS Growth 1.5% 47.6% 15.9% 13.0% Total Non-interest Income 275.4 420.2 433.5 504.1 P/E 19.0 12.9 11.1 9.8 Total Banking Income 901.3 1,293 1,566 1,858 General & Administrative Expenses (282.8) (376.6) (474.8) (577.5) DPS 0.42 0.49 0.38 0.54 Provisions for Customer Loans (21.2) (25.8) (58.8) (114.2) Dividend Yield 4.1% 4.8% 3.8% 5.4% Provisions for other losses - - - - Income before Taxes & Minority Interest 597.4 890.7 1,032.1 1,166.1 BVPS 2.95 3.54 4.07 4.56 Tax & Zakat - - - - P/BV 3.46 2.88 2.51 2.24 Net Income before Minority Interest 597.4 890.7 1,032.1 1,166.1 Minority Interest - - - - Mkt Cap / Loans 90.7% 59.3% 45.7% 38.1% Net Income 597.4 890.7 1,032.1 1,166.1 Ratios Growth in Net Loans 35.3% 52.9% 29.8% 19.9% Growth in Deposits 29.3% 33.0% 29.5% 20.0% Loans / Deposits 91.9% 105.7% 105.8% 105.7% Growth in Net Interest Income 38.2% 39.5% 29.7% 19.6% 10 Growth in Non-Interest Income -16.8% 52.6% 3.2% 16.3% Growth in Operating Expenses 23.0% 33.2% 26.1% 21.6% Growth in Provisions Made 113.2% 22.0% 127.8% 94.3% 9 Growth in Net Income 9.9% 49.1% 15.9% 13.0% Net Interest Spread 3.31% 3.62% 3.54% 3.44% Net Interest Margin 3.83% 4.15% 4.00% 3.88% 8 Non-Interest Income / Revenues 30.6% 32.5% 27.7% 27.1% Cost / Income 31.4% 29.1% 30.3% 31.1% 7 Provisions Made / Average Gross Loans 0.19% 0.17% 0.26% 0.41% Net Loans / Assets 67.6% 73.9% 75.4% 75.8% Customer Deposits / Liabilities + SHF 73.5% 69.9% 71.2% 71.7% 6 Capital Adequacy Ratio 20.2% 16.8% 15.0% 14.0% Growth in NPLs -3.9% 53.3% 29.8% 19.9% NPLs / Gross Loans 2.3% 2.3% 2.3% 2.3% NPL Coverage Ratio 87.6% 57.9% 50.8% 55.0% 11-Jul-07 11-Jan-07 11-Apr-07 11-Jun-07 11-Sep-07 11-Feb-07 11-Aug-07 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-Dec-06 11-May-07 RoAE20.0% 24.3% 24.0% 23.9% RoAA 3.5% 4.0% 3.5% 3.2% Prices as at 11 December 2007 Source: CBD, EFG-Hermes estimates
Raj Madha, CFA 42 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: customer segmentation bring results 2008: further rollout uae research yearbook 2008
background CBD is the smallest of the UAE's nine big banks in terms of market cap. It has a significant retail banking division, though its main focus is on commercial banking. The Dubai government owns 20% of CBD, and a number of prominent UAE citizens hold other substantial stakes.The bank is not open to foreign participation. CBD's branch network of 24 branches is heavily focused on Dubai, but it has a solid presence in Abu Dhabi and branches in some of the other emirates as well. 2007 - strong momentum for core earnings
Peter Baltussen took hold of the reins of CBD as CEO in July 2006 and inherited a bank with already strong loan growth and wide margins, reflecting significant exposure to the mid-market. However, the challenge was both to secure the customer base by increasing approval ratings and to go after new business by segmenting the client base and therefore improving customer targeting.
Although CBD has focused predominantly on corporate customers, 2007 has also been a year of change on the retail side, where a similar segmentation has taken place. Al Dana Services, a wealth management operation, was launched in June 2007, targeting high net worth individuals, while the mid and lower income clients have been guided towards the use of improved direct banking channels. The product offering was also boosted recently by the decision to move into home financing, with an aggressive mortgage product that offers easier terms and conditions.
Results so far have been positive. Trade and construction lending have accelerated, while personal lending for business purposes has jumped. CBD has continued to maintain the widest interest spreads in the market, driven on the asset side by high mid-market exposure and low exposure to the public sector and interbank debt, and on the liability side by a relatively low amount of high-cost funding. Good loan growth, combined with solid spreads, has driven strong net interest income. Loan growth has also fed through to an uplift in fees and commissions. Meanwhile, cost growth completed an investment cycle by mid-year 2007 and has since eased. 2008 - rolling out products and branches
Overall, the picture going into 2008 is one of an accelerating franchise driven by better client servicing, and a better focus on an underserved area of the market. Indeed 2008 will be a year of further branch growth as CBD aims to get closer to some of its customers.
Also to complement its high net worth offering, CBD is looking to start up an Islamic window to begin offering a broader range of Islamic financial products. While clearly CBD is in no way first to discover the Islamic finance market, it is clear that it is working hard to infill areas which may slow or threaten steady increases in market share.
We remain convinced, however, that the principal engine of growth is the SME segment, which accounts for perhaps 30% of GDP. Indeed, trade finance has been a steady growth segment for CBD over recent years, but personal lending for business purposes has been the big surprise of 2007. Going forward, we expect significant future growth to be from here. The only negative we see this year is potentially higher provisioning, as there is likely to be a higher degree of cyclicality in the SME segment than elsewhere. recommendation On a 2007 P/E basis, CBD is the cheapest in the sector at 12.9x. In addition, we believe that it has made significant improvements in its ability to target its core customer base, and is likely to grow strongly as a result.There are concerns that provisioning will be an issue over the next couple of years, but with liquidity high and recent experience positive, we believe that is not yet a concern. Competition will no doubt heat up in this area, but for now CBD is the only bank to make this segment its own.The stock is also relatively inexpensive on a price-to-book basis, at 2.9x, although there are many that are cheaper. We have a ST/LT Buy, with upside of 32% to the current market price.
banking sector | cbd 43 dubai islamic bank (dib)
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Accumulate Current Price: AED10.9 Balance Sheet LT Rec. Neutral LT Fair Value : AED 11.2 Cash 3,112 4,613 6,002 7,196 Due from Banks 15,398 11,042 10,019 11,212 Net Loans (Conventional & Islamic) 35,255 51,333 66,795 80,082 Other Interest Earning Assets - - - - Tradeable Assets & Associates 7,671 8,526 9,609 10,446 Stock Data Property and Equipment 496 545 654 753 Last Ex-Div Date AED0.35 on 4 Mar 2007 Other Assets 2,502 2,665 3,241 4,240 Mkt Value (Local mn) AED32,656 Total Assets 64,434 78,725 96,321 113,929 Shares (mn) 2,996 Customer Deposits 47,732 61,098 76,372 91,646 Av. Mthly Liquidity (mn) AED1,954 Due to Banks 4,650 1,123 1,404 1,685 52-Week High/Low AED11.45 / 6.09 Medium Term Notes & Other CM Funding - 2,755 2,755 2,755 Other Financial Liabilities - - - - Bloomberg/Reuters DIB UH / DISB.DU Other Operating Liabilities 4,207 4,310 5,218 6,213 Est. Free Float 43.7% Total Liabilities 56,590 69,285 85,749 102,299 Shareholders' Equity 7,557 9,069 10,157 11,172 Minority Interest 287 371 416 457 Total Liabilities & Equity 64,434 78,725 96,321 113,929 Income Statement Net Interest Income 1,098 1,511 2,066 2,200 Net Commission Income 906.7 798.0 997.6 1,197.1 Brokerage & Fund Management - - - - (AED) 2006a 2007e 2008e 2009e Income from Investments & Associates 127.6 692.4 569.8 715.4 EPS 0.50 0.82 0.70 0.72 Property Income 555.7 244.4 184.1 135.0 Other 115.6 774.8 197.0 236.4 EPS Growth 37.7% 63.3% -14.7% 3.8% Total Non-interest Income 1,706 2,510 1,948 2,284 P/E 21.8 13.4 15.7 15.1 Total Banking Income 2,803 4,021 4,015 4,484 General & Administrative Expenses (1,148) (1,402) (1,665) (1,977) DPS 0.33 0.31 0.33 0.38 Provisions for Customer Loans (76.5) (174.0) (264.6) (344.0) Dividend Yield 3.0% 2.9% 3.1% 3.5% Provisions for other losses - - - - Income before Taxes & Minority Interest 1,579 2,444 2,085 2,163 BVPS 2.52 3.03 3.39 3.73 Tax & Zakat (75.8) - - - P/BV 4.33 3.60 3.22 2.92 Net Income before Minority Interest 1,503 2,444 2,085 2,163 Minority Interest (17.8) - - - Mkt Cap / Loans 92.6% 63.6% 48.9% 40.8% Net Income 1,485 2,444 2,085 2,163 Ratios Growth in Net Loans 24.6% 45.6% 30.1% 19.9% Growth in Deposits 42.9% 28.0% 25.0% 20.0% Loans / Deposits 73.9% 84.0% 87.5% 87.4% Growth in Net Interest Income 76.7% 37.7% 36.8% 6.5% 12 Growth in Non-Interest Income 49.0% 47.1% -22.4% 17.2% 11 Growth in Operating Expenses 99.7% 22.1% 18.7% 18.7% Growth in Provisions Made -41.3% 127.5% 52.1% 30.0% 10 Growth in Net Income 48.8% 54.8% -14.7% 3.8% Net Interest Spread 1.89% 2.37% 2.37% 2.33% 9 Net Interest Margin 2.31% 2.47% 2.55% 2.43% 8 Non-Interest Income / Revenues 60.8% 62.4% 48.5% 50.9% Cost / Income 41.0% 34.9% 41.5% 44.1% 7 Provisions Made / Average Gross Loans 0.23% 0.40% 0.45% 0.47% Net Loans / Assets 54.7% 65.2% 69.3% 70.3% 6 Customer Deposits / Liabilities + SHF 74.1% 77.6% 79.3% 80.4% 5 Capital Adequacy Ratio 20.3% 18.3% 17.1% 15.8% Growth in NPLs ---- NPLs / Gross Loans 0.0% 0.0% 0.0% 0.0% NPL Coverage Ratio ---- 11-Jul-07 11-Jan-07 11-Apr-07 11-Feb-07 11-Jun-07 11-Aug-07 11-Sep-07 11-Nov-07 11-Dec-06 11-Mar-07 11-Oct-07 11-Dec-07 11-May-07 RoAE27.1% 29.4% 21.7% 20.3% RoAA 2.8% 3.4% 2.4% 2.1% Prices as at 11 December 2007 Source: DIB, EFG-Hermes estimates
Raj Madha, CFA 44 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: weak second half 2008: steadying the helm uae research yearbook 2008
background DIB is the UAE's largest Islamic bank, and its fourth largest when conventional banks are included as well. It has 34 branches distributed nearly proportionately across the emirates, with a slight bias towards the more conservative emirate of Sharjah. DIB's business is primarily lending to the property sector, although it has only latterly got involved in residential mortgages. It is also the global leader in the issuance of sukuks, or Islamic bonds, with a dominant market share.
DIB has two substantial minority non-banking associates, 43%-owned property company Deyaar and 19%-owned housing finance company Tamweel.Combined, these holdings are capitalized at AED8.5 billion, or roughly 25% of DIB's market capitalization. In addition, it has a 27% stake in Bosnia International Bank, stakes in two Sudanese banks and other non-banking interests.The bank has a free float of 45%, with the Dubai government and a number of prominent families holding the rest. GCC and foreign investors are allowed to own up to 15% of the bank. 2007 - started fast
Following a year of steady product development and franchise and network investment, including a 60% jump in the number of branches, 2007 was set to be a good year. Indeed, expected 2007 results on an underlying basis are essentially unchanged from those a year ago. On a quarterly basis, however, the picture is slightly different. Results in 1H2007 were strong, with Islamic financing growing 53% Y-o-Y, driving strong net Islamic returns, while fees and commissions and costs brought the overall result down, albeit with strong quality (recurring element). This was substantially reversed in 3Q2007. Although Islamic financing continued to grow strongly (+51% Y-o-Y), weak (and in fact negative) deposit growth took the legs from the growth of net Islamic returns.This was compensated by better cost growth and a recovery in fee incomes.
While we end the year roughly where we began in terms of future expectations, this is with slightly weaker momentum. However, while 3Q2007 results are modestly below expectations, the strong performance of property spin-off Deyaar suggests that there was underappreciated value in its property development arm. Indeed of the combined value of the stakes in Deyaar and associate Tamweel is now equivalent to 25% of market capitalization of DIB. 2008 - taking advantage of abundant islamic banking opportunities
The first thing to achieve in 2008 is to reassure investors that the deposit shortfall that led to the disappointing 3Q2007 results was a one-off. Part of this could be related to the yet-to-be-replaced CEO of the bank, Saad Abdul Razak, who was asked to join Investment Corporation of Dubai, an investment agency within the government of Dubai. Simultaneously, with Emirates NBD attracting spare deposits from everywhere in the market, it may also have been a temporary slippage of competitive position. Overall in 2008, we forecast a return to balanced growth for the balance sheet, driving strong net Islamic returns and in turn profitability.
Apart from our concerns over deposit weakness and management departures, we highlight only the potential impact of increased competition on DIB's franchise. Millennium Capital, DIB's investment banking arm, is clearly earning the attention of international competitors, while in the Islamic banking arena Al Noor Bank of Dubai and Al Hilal Bank of Abu Dhabi may begin to raise the stakes. recommendation On a 2006 PE basis, DIB is valued at a small premium to the sector at 13.4x. It is a quality player in Islamic banking, but the space is likely to become increasingly competitive. For the moment we are positive on the stock, based on an expectation of strong 4Q2007 earnings, and the value realizable from its associates (primarily Deyaar and Tamweel). Overall, we estimate a LT Fair Value for the stock of AED11.15, indicating upside of 3% to the current market price. We assign a ST Accumulate / LT Neutral rating for the stock.
banking sector | dib 45 abu dhabi islamic bank
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Reduce Current Price*: AED 63.8 LT Rec. Neutral LT Fair Value : AED 56.6 Balance Sheet Cash 1,408 1,943 2,330 2,862 Due from Banks 10,559 13,089 13,409 15,003 Net Loans (Conventional & Islamic) 20,437 23,797 28,530 32,900 Other Interest Earning Assets 1,671 2,262 2,488 2,737 Stock Data Tradeable Assets & Associates 1,617 1,698 2,207 2,428 Property and Equipment 213 118 130 143 Last Ex-Div Date AED1.00 on 17 Apr 2007 Other Assets 385 667 790 897 Mkt Value (Local mn) AED12,563 Total Assets 36,290 43,573 49,884 56,970 Shares (mn) 197.1 Customer Deposits 23,822 30,492 35,066 40,326 Av. Mthly Liquidity (mn) AED690.0 Due to Banks 5,346 3,659 3,612 4,033 52-Week High/Low AED69.35 / 46.10 Medium Term Notes & Other CM Funding 2,938 2,938 3,938 4,438 Bloomberg/Reuters ADIB UH / ADIB.AD Other Financial Liabilities - - - - Est. Free Float 24.0% Other Operating Liabilities 1,576 1,372 1,543 1,790 Total Liabilities 33,682 38,462 44,158 50,586 Shareholders' Equity 2,607 5,110 5,723 6,381 Minority Interest 1 2 3 3 Total Liabilities & Equity 36,290 43,573 49,884 56,970 Income Statement Net Interest Income 781.3 1,190 1,384 1,557 Net Commission Income 106.7 113.3 147.3 176.8 Brokerage & Fund Management - - - - (AED) 2006a 2007e 2008e 2009e Income from Investments & Associates 110.1 28.3 36.0 45.2 EPS 3.77 3.50 3.82 4.24 Property Income - - - - EPS Growth 59.2% -7.1% 9.2% 10.8% Other 0.7 - - - P/E 16.9 18.2 16.7 15.1 Total Non-interest Income 217.5 141.6 183.4 222.0 Total Banking Income 998.8 1,332 1,567 1,779 DPS 1.00 0.77 0.71 0.90 General & Administrative Expenses (380.1) (569.2) (682.0) (786.3) Dividend Yield 1.6% 1.2% 1.1% 1.4% Provisions for Customer Loans (48.1) (113.1) (131.9) (158.3) Provisions for Other Losses - - - - BVPS 17.38 25.93 29.04 32.38 P/BV 3.67 2.46 2.20 1.97 Income before Taxes & Minority Interest 570.6 649.3 753.1 834.6 Tax & Zakat (11.4) - - - Mkt Cap / Loans 61.5% 52.8% 44.0% 38.2% Net Income before Minority Interest 559.1 649.3 753.1 834.6 Minority Interest (0.9) - - - Net Income 558.2 649.3 753.1 834.6 Ratios Growth in Net Loans 53.0% 16.4% 19.9% 15.3% Growth in Deposits 32.1% 28.0% 15.0% 15.0% Loans / Deposits 85.8% 78.0% 81.4% 81.6% 70 Growth in Net Interest Income 20.2% 52.3% 16.3% 12.5% Growth in Non-interest Income 232.3% -34.9% 29.5% 21.1% 65 Growth in Operating Expenses 64.3% 49.7% 19.8% 15.3% Growth in Provisions Made -65.5% 134.9% 16.7% 20.0% 60 Growth in Net Income 65.6% 13.8% 16.0% 10.8% Net Interest Spread 2.23% 2.69% 2.77% 2.73% 55 Net Interest Margin 2.66% 3.11% 3.18% 3.11% Non-interest income / Revenues 21.8% 10.6% 11.7% 12.5% 50 Cost / Income 38.1% 42.7% 43.5% 44.2% Provisions Made / Average Gross Loans 0.27% 0.52% 0.50% 0.52% 45 Net Loans / Assets 56.3% 54.6% 57.2% 57.8% 40 Customer Deposits / Liabilities + SHF 65.6% 70.0% 70.3% 70.8% Capital Adequacy Ratio 12.2% 21.0% 19.9% 19.5% Growth in NPLs -100.0% - - - NPLs / Gross Loans 0.0% 0.0% 0.0% 0.0% 11-Apr-07 11-Jan-07 11-Jun-07 11-Jul-07 11-Feb-07 11-Sep-07 11-Oct-07 11-Dec-07 11-Dec-06 11-Mar-07 11-Aug-07 11-Nov-07 11-May-07 NPL Coverage Ratio RoAE24.2% 16.8% 13.9% 13.8% RoAA 1.9% 1.6% 1.6% 1.6% Prices as at 11 December 2007 Source: ADIB, EFG-Hermes estimates
Raj Madha, CFA 46 +971 4 363 4009 uae research yearbook 2008 [email protected] 2007: going sideways 2008: awaiting new strategy uae research yearbook 2008
background Abu Dhabi Islamic Bank is the second of the UAE's four established Islamic banks and the seventh largest listed bank in the UAE. It has five divisions: corporate, commercial banking, retail banking, treasury and fixed income and investment banking. The corporate division focuses on Islamic finance and project finance. Within personal banking, the bank has historically focused on high-net-worth UAE citizens, but this is now changing. The investment banking division is limited to managing ADIB's portfolio assets and strategic investments and to running the fund management business for the other areas of the bank.
The bank has 39 branches in the UAE, focused in Abu Dhabi and Al Ain. It is majority owned and controlled by Emirates International Investment Company (EIIC) and by leading Abu Dhabi families, although the government also holds a significant stake. The main investment is ADIB Egypt, formerly known as National Bank for Development. 2007 - strategic drift
Emirates International Investment Company (EIIC) took control of ADIB in 1Q2007 with the apparent intention of taking a "softly, softly" approach to maximizing value at ADIB. It would seem that initially the idea was to gradually guide ADIB into deepening its product portfolio and administering a franchise overhaul. This approach seems to have been rethought. 2Q2007 results, weighed down by the dilutive impact of the convertible, failed to surprise positively. Meanwhile, 3Q2007 results suggested that growth is slowing and we now forecast the weakest customer asset growth in the sector for ADIB.
The other major development for ADIB was the decision, jointly with EIIC, to buy 51% of National Bank for Development and rename it ADIB Egypt. While the headline acquisition price was modest, ADIB Egypt needed to be substantially recapitalized, significantly increasing the sunk costs. This was, however, not a surprise, and may indeed suggest that integration plans are moving ahead rapidly.
The lack of positive progress in the core franchise would seem to have prompted EIIC to take a more hands-on approach going forward. In particular, ADIB strengthened its board with the addition of Khamis Buharoon, previously CEO of CBI and head of domestic banking at NBAD, as managing director. Meanwhile, board member Ragheed Najib al-Shanti has taken over as acting CEO while a permanent CEO is found. 2008 - rebuilding aggression
It is clear what ADIB needs to do, at least in general terms. It needs to appoint a permanent CEO, then build a strategy and once more go after customers aggressively, with an evolving product range which meets their needs. Furthermore, the lack of cross-sell has meant that non-interest income has made relatively little progress over the last couple of years. Indeed non-interest income as a proportion of revenues is the lowest in our universe and declined sharply in 2007 as trading revenues dropped, while fees and commissions failed to make positive progress.
As well as resolving its management and strategic issues, we also would like to see synergies come through between EIIC and ADIB,and potentially between ADIB and ADIB Egypt. We do not yet have a clear idea of what ADIB's plans are for ADIB Egypt: cleaning up the bank with a cash injection is the relatively easy first step, but turning round the bank so the quality of the remaining book stabilizes will be harder. In addition, the bank may need to be converted into an Islamic bank. Consequently, there is a lot to achieve in 2008. recommendation ADIB, at 18.2x 2007 earnings, is the most expensive bank in our universe. This, however, has really been the result of weak trading in generally easy trading conditions. New management may well be able to turn the business around and find value in a franchise which has, to some extent, atrophied in relative terms. At this point, however, this is far from visible. We remain optimistic for the value realizable at ADIB and the synergies from a closer working relationship with parent company EIIC, but for now we are more concerned at the lack of positive developments in its core business. The stock is cheap on a price-to-book basis, with a 2007e multiple of 2.5x, but for now we are content to leave it that way. We assign a recommendation of ST Reduce / LT Neutral with a LT Fair Value of AED56.6, representing 11% downside to current market levels.
banking sector | adib 47 housing finance sector
2007 year in review
2007 was turbulent for the housing finance sector. With the two companies, Amlak and Tamweel, having started the year expecting a banking license, investors were hit hard when Amlak announced it had heard unofficially that its application had been denied.While the central bank denied any such decision, its clarification only muddied the waters further, but was eventually taken as an indefinite postponement for both companies, with Amlak's license being more unlikely than Tamweel's. Since then, the housing finance companies have set themselves the primary task of reformulating their funding strategies.
In previous years, the housing finance sector has been funded principally by equity, although loans from principle shareholders have also been a significant driving force. In addition, Amlak had offered a corporate sukuk, or Islamic bond, while Tamweel had embarked in its first securitization issue. This, however, was not really scalable. With capital adequacy ratios around 37%, it was clear that a decent return on equity was going to be difficult. Furthermore, this funding from senior shareholders had been manageable while the companies were small, but more difficult as the companies grew.This is where the retail deposits were supposed to come in: retail deposits provide a scalable cheap source of funding. However, without a banking license retail deposit funding became impossible, prompting the change.
In the short term, the fall-back plan was always going to be corporate investment deposits.These are loans from public pension schemes, quasi-state bodies and large corporate enterprises, from whom the potential funding pool is large. Furthermore, by being flexible on tenure, and paying up, the housing finance companies have suggested that they are able to attract a near unlimited pool of liquidity. The trick though is to obtain liquidity that does not upset asset liability management, and for that, the housing finance companies need term deposits with as great a tenure as possible. The result, at least for Tamweel, is that it is critically dependent on a relatively small pool of investors, who are happy to make six-month or one-year deposits for relatively small premiums to interbank rates. Clearly pension funds, with their own long-term liabilities, are the ideal candidates.
Fig 1: Breakdown of Funding Amlak Fig 2: Breakdown of funding Tamweel
8,000 Amlak Sukuk 10,000 Corporate Investment deposits Securitisation 7,000 Shareholders' Funds Due to related parties 8,000 Corporate Investment deposits 6,000 Shareholders' Funds
5,000 6,000 4,000 3,000 4,000 2,000 2,000 1,000
0 0 2006 1Q2007 2Q2007 3Q2007 2007 2006 1Q2007 2Q2007 3Q2007 2007
Source: Quarterly reports, EFG Hermes Source: Quarterly reports, EFG Hermes
The second scalable option is that of securitization. Following Amlak's perceived difficulties in getting a banking license, Tamweel was the first to respond. It had, of course, already issued its first securitization. However this next securitization was for cash-collateralized, residential mortgage-backed securities within a formalized issuance program. The timing for this was good, with the securities being issued immediately before credit markets began to experience problems in August. The pricing was strong, with 85% of the AED710 million issue rated AA and priced at LIBOR + 30 basis points, with even the blended yield for the top three tranches that it sold on (AA, BBB+ and BB-) amounting to no worse than 51 basis points.
Although corporate investment deposits and securitization are likely to provide the bulk of the funding, it is likely that corporate sukuk will also provide a certain amount. One new further source of funding has been that from escrow accounts. Escrow accounts have been developed as ring-fenced intermediary accounts between purchasers of property and property developers. While both companies now have obtained permission to open escrow accounts, raising actual balances on these accounts will need to wait until 2008.
While the excitement, at least for the early part of the year, was all about the funding side of the balance sheet, the asset side of the balance sheet was equally important. As we can see in Figure 3, at least for the first half of the year, growth for the banking sector as a whole continued at above the 90% level (Y-o-Y) for a tenth consecutive quarter, although this figure includes commercial real estate. Growth rates for Amlak and Tamweel, while not quite that good, were nevertheless very strong. Tamweel in particular benefited from an extraordinary 3Q2007, where its rate of new additions doubled from 1H2007 levels.
48 uae research yearbook 2008 2007: outgrowing license disappointment 2008: delivering returns on equity uae research yearbook 2008
Fig 3: Total Real Estate Mortgages Fig 4: Asset Growth
10,000 Loan Commitments 100,000 Residents 94% Securitised Loans % from Domestic Institutions 93% On-BS Loans 8,000 92% 91% +60.6% 6,000 90% +32.4% 89% 92% CAGR 88% 4,000 87% 86% 2,000 85% 84% 0 10,000 83% 06 07 4Q 06 3Q 07 Tamweel Tamweel Amlak 4Q Amlak 3Q 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 Source: CB statistical releases Source: Quarterly reports, management discussions
We believe the key to finding value in the housing finance stocks is not so much in their growth rate as in their returns on equity.These have generally been poor, rarely exceeding the cost of equity by more than a percentage point or two over the lifetime of the companies. Clearly, if companies can return only their cost of equity, they would not be worth substantially more than book value, so the question is are these returns understated and to what extent can they be improved? Indeed, given that 3Q2007 return on equity at Tamweel jumped to a level of 29%, to what extent is this maintainable?
The first point to note is that measured spreads have been low for Amlak and non-existent for Tamweel.Tamweel maintains that this is substantially due to the impact of rising LIBOR (EIBOR) rates during the period from June 2004 to June 2006. Since many floating rate loans are fixed for the first year or two (between the point of purchase and the point of handover), this will have a negative impact on reported spreads when interest rates are rising. In 3Q2007, LIBOR didn't just stabilize, it actually fell, boosting spreads significantly. Furthermore, spreads were also given a boost by the first securitization under the new program. Securitization involves the removal of most of the associated balance sheet items, but leaves in the net positive in interest income, overall positively impacting reported spreads.
Fig 5: ROE Amlak Fig 6: ROE Tamweel
14% 35%
12% 30%
10% 25%
8% 20%
6% 15%
4% 10%
2% 5%
0% 0% 2Q2005 3Q2005 4Q2005 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 3Q2007 4Q2004 1Q2005 2Q2005 3Q2005 4Q2005 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 3Q2007 Source: Amlak, annual reports Source: Tamweel, annual reports
This positive impact on spreads was supplemented by high levels of fee and commission income driven by high levels of origination in 3Q2007. Combined with higher gearing levels, inevitably this led to higher returns on equity.
housing finance sector 49 housing finance sector
2008 outlook
Although growth rates for the sector have been huge in the past, penetration of mortgages is still very low, representing slightly over 2% of GDP. Mortgages will be driven by property transactions, which in the short term will be driven by property supply and further out by population dynamics. Over the next five years, we estimate a population increase of 1.4 million people, implying property transactions of AED683 billion. Assuming that 21% of this is financed (30% of properties mortgages with an average LTV of 70%), this indicates a market size of AED161 billion, up from an estimated existing market size of only AED16 billion.
Although the housing finance companies estimate an existing market share of the existing stock greater than 30% each, we believe the banks are likely to be more aggressive in this segment going forward than they have been in the past. Consequently, we believe that this will reduce the market share of Tamweel and Amlak going forward, but that ultimately this would also put pressure on spreads. We model this by indicating front book spreads under pressure from 2009, in turn of course putting pressure on back book spreads. However, since securitization has a positive influence on reported spreads and because securitization will be an increasingly important funding tool, overall spreads are likely to be near stable.
Fig 7: Asset Spreads - Amlak Fig 8: Asset Spreads - Tamweel Front Book Front Book Back Book Back Book 290 Total Asset 350 Total Asset
270 300 250
230 250 210
190 200 170
150 150 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012
Source: EFG-Hermes estimates Source: EFG-Hermes estimates
On the funding side, the key challenge will be for Tamweel to continue its securitization program, and for Amlak to embark on its first securitization, as soon as the credit markets settle down. Both Amlak and Tamweel see securitization as a major source of funding in the future, but clearly with asset backed securities falling into disfavor in the short term this is going to make issues of this kind more difficult and/or expensive near term. Corporate sukuk issuance is also likely to return, and we believe that they are both likely to tap the sukuk market for liquidity next year. Overall, we estimate that both companies will be able to raise about AED2 billion from credit markets and a further AED2 billion from investment deposits each.
As for escrow accounts, while the sums being paid into escrow accounts are very large, we believe the balances on this business will be reduced by competitive erosion as both buyer and seller fail to benefit from these balances. We estimated that Amlak and Tamweel are both well-positioned to accumulate balances, but even assuming a substantial market share, we estimate that at the peak this will only amount to around AED1.5 billion each. Meanwhile, in the first full year of operation, we expect the balances to be only incremental in nature.
50 uae research yearbook 2008 2007: outgrowing license disappointment 2008: delivering returns on equity uae research yearbook 2008
Fig 9: Changes in Funding 2008 - Amlak Fig10: Changes in Funding 2008 - Tamweel
Securitisation Securitisation Sukuk Sukuk Due to related parties 14,000 Corporate Investment deposits 16,000 Escrow account deposits Corporate Investment deposits Escrow Accounts 12,000 Shareholders' Funds 14,000 Shareholders' Funds 12,000 10,000 10,000 8,000 8,000 6,000 6,000 4,000 4,000 2,000 2,000
0 0 2007 2008 2007 2008 Source: EFG-Hermes estimates Source: EFG-Hermes Estimates
There is also the possibility that there will be some resolution on the banking license issue. Amlak's comments notwithstanding, it is still possible they will be awarded a banking license, and even if they are not, there is a possibility that one or other housing finance company will look to acquire a license through the back door, by acquisition either of a bank or a stand-alone banking license. Finally Tamweel have pointed out the possibility that there will be a regulatory change which obviates the need for a banking license. We do not forecast any of these happening, but nonetheless, these would, in principle, provide upside for our fair value estimates. diversification strategy Both companies have started to build property portfolios. In the case of Tamweel, the idea is to buy wholesale plots of land and sell them on retail in a comparatively short space of time. In addition, the main concern is the weight this would put on the balance sheet, but Tamweel maintains that this can be financed significantly with accruals. As a result, in a rising market, we believe that Tamweel can get strong returns from this business, although in a flat or falling (or even slow moving) property market, this may be significantly tougher. Consequently, in the short term we forecast good profitability, although we expect this to evaporate over the medium term.
Subject to confirmation, we believe that Amlak's property portfolio is of a similar nature to that of Tamweel and model it accordingly. Meanwhile, the rest of the strategy follows on from the mid-2007 strategic review, which has not formally yet been released to the market. Nevertheless, management have indicated firstly a cutting of its extraneous business and then diversifying. The business to be cut includes its vehicle financing business and share financing operation, both of which will be put into run off. Amlak have talked about diversifying products along two axes: the property sector and the personal finance sector. In the first category are projects close to home, like commercial mortgages, and those further away, like property brokerage. The second category might include anything and everything from credit cards to educational loans.
Geographically, their intentions are more similar, with the companies not willing to rule out the possibility of investing almost anywhere across North Africa or the subcontinent. Egypt and Saudi Arabia are existing common markets for each of them. Meanwhile, Amlak is also strongly considering investments in Jordan, Bahrain and Qatar. Tamweel has highlighted India and Turkey. risks The primary risk that seems to be of concern to the market is that of a property price decline leading to high default rates. On this risk we are relatively sanguine. While there is a significant amount of property supply coming to the market, we believe that in a high immigration environment, particularly when assisted by a positive demographic impact from the high growth rate of the National population, unless there is a significant interest rate (or cost of ownership) shock, prices are unlikely to be significantly impacted in the medium term. Furthermore, even if there is a property price adjustment, we believe that the risk of a significant NPL or provisioning problem is small. Property loans are generally over-collateralized and either linked to salary accounts or supported by drawn checks. Consequently, unless those in negative equity decided also to skip the country the risk is low. This as far as we can tell would not be a serious problem, unless property prices affected sentiment so strongly that transaction volumes were affected.
Of more concern is the possibility of the banks becoming more and more competitive in this field. Certainly it is true that some banks such as Emirates NBD and ADCB have become more aggressive, while others have eased off. Nevertheless, we believe that as a whole competition from the banks will be on a rising trend. Although we have factored this into our forecasts by way of pressure on front book spreads, it is possible that the pressure on spreads will be much greater than we have forecast.
Raj Madha, CFA +971 4 363 4009 housing finance sector 51 [email protected] 52 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 /V()4237282.5 1.98 0.03 2.8 1.77 - 3.7 0.6% 1.34 77.7% - 20.5 4.2 0.0% 103.2% 1.18 150.9% 24.2 0.0% 0.24 - 294.2% 0.0% 30.5 0.20 18.1% 0.24 60.3 25.9% 0.16 Market Cap /Deposits 0.20 97.7% 0.08 P/BV (x) 0.16 -68.6% BVPS 0.08 Div. Yield DPS P/E (x) EPS Growth EPS (Normalized) EPS (AED) Est. Free Float Bloomberg/Reuters 52-Week High/Low Av. Mthly Liquidity(mn) Shares (mn) Mkt Value (Localmn) Last Ex-Div Date Data Stock
11-Dec-06 Reduce LT Rec. Reduce ST Rec.
11-Jan-07
11-Feb-07 [email protected] +971 43634009 CFA Raj Madha,
11-Mar-07
11-Apr-07
11-May-07 06 07 08 2009e 2008e 2007e 2006a
11-Jun-07 49% / AMLK.DU AMLAK:UH 5.66 /2.73 AED2,147 1,500 AED7,380 N/A amlak finance amlak LT Fair AED3.34 Value : AED4.92 Current Price:
11-Jul-07
11-Aug-07
11-Sep-07
11-Oct-07
11-Nov-07
11-Dec-07 oA .%37 .%2.6% 12.8% 3.2% 13.4% 3.7% 12.8% 28.6% 2.5% 6.9% 26.7% 27.0% 32.6% 3.0% 29.2% 2.2% 18.1% N/A 31.8% 3.2% N/A 153.1% 2.3% 34.5% 10.7% RoAA* 38.9% -21.1% 33.9% N/A 3.0% N/A RoAE* 97.7% N/A 1.8% 22.3% Provisions Made/ Av. 45.2% 11.1% Gross Loans 62.9% 3.1% N/A N/A Cost /Income 25.7% N/A 152.9% 1.5% 67.4% Growth inNet Attributable Income(YoY) 28.1% 47.4% Growth inProvisions Made(YoY) 22.4% N/A N/A 32.9% 395 133.2% Growth in Operating Expenses(YoY) 87.7% N/A 37.0% Growth inNon-Interest Income(YoY) 20.4% 384 120.1% 46.1% N/A Growth inNetInterest Income(YoY) 334 53.8% 128.1% Net Interest Margin* 26.2% 95.0% (52) 325 Net Interest Spread* 162.5% 448 249 38.6% 24.2% Write-offs / Gross Loans 15.6% NPL Coverage Ratio 242 (40) (179) 35.2% 374 NPLs / Gross Loans 119 627 7 150 Growth inNPLs(YoY) (106) (16) (136) 122 Growth inNetLoans(YoY) - 265 269 (74) Growth inDeposits(YoY) 510 26 132 (75) (98) 85 6 (20) Loans /Deposits 139 Capital 243 Adequacy Ratio (61) - 363 69 (54) Ratios 30 (67) 75 5 Net Attributable Income 198 (44) 44 207 Pretax Income (34) - - 61 Provisions for LoansLosses 63 358 78 (34) Income before Provisions 20 - Total Operating 3,177 13,385 Expenses 25 - Other General & Adm. Expenses 34 268 1,140 9,704 Salaries &Employee Related Costs 2,836 - Total BankingIncome 164 858 5,902 2,698 Total 2,011 Non-Interest Income 16,562 Other Operating Income 3,277 1,698 income Property 312 1,769 128 - 12,540 672 Trading &Investments 698 7,913 Fees & Commissions 71 9,503 632 Dividend Income 1,139 Net Interest 5,046 &IslamicReturns 2,092 12,659 698 7,148 Income Statement 1,704 267 Shareholders' Equity 8,587 1,618 4,892 Total Liabilities 232 88 Proposed Dividend 6,267 1,146 Other Operating 2,509 Items 268 Capital MarketLiabilities 4,076 614 Customer Deposits&IslamicFunding Total Assets Fixed Assets & Other Assets Other Investments & Associates Loans &IslamicFinancing Cash &BankDeposits Balance Sheet December Year End(AEDmn) Sources: Amlak, EFG-Hermes estimates Prices asat11December2007 *Annualized for data quarterly uae research yearbook 2008 yearbook uae research 06 2007e 2006a .5 .0 .1 0.43% 0.51% 0.30% 0.55% / / / N/A N/A N/A N/A --- 2008e 2009e 2007: no license, new management 2008: new management, new markets uae research yearbook 2008
background Amlak was established by Emaar properties in 2000 to provide housing finance for its customers. The company was converted into an Islamic finance company in 2004 and then partially spun off. Amlak is primarily a residential mortgage provider, but in addition has diversified into commercial mortgages and vehicle (auto and yacht) financing. Amlak historically has also had significant exposure to share financing. Amlak currently has emergent operations in Egypt and Saudi Arabia and is planning further international diversification. 2007 - a year of change
Amlak started the year disappointingly, with results for 1Q2007 suggesting that it was continuing to lose market share to its younger rival Tamweel. In addition, the endless postponement of the banking license it was seeking began to add to the sensation that strategy was going adrift. Consequently, when a new chairman and a new CEO were appointed at the end of 1Q2007, some shift in emphasis was to be expected. The immediate change was to trim back on the existing product/brand extensions to reposition the company to compete in areas it felt it had a relative advantage. Consequently, the diversifications into auto and share financing were put into run off, and the company was repositioned as a pure mortgage player, focused primarily on the residential market, albeit with a significant exposure to commercial mortgages.
From this narrower product base, management then looked to see what product/brand extensions could and should be built around its core mortgage platform. The conclusion was to stretch the brand in two directions - personal finance and real estate - with the former including credit card services, for example, and the latter real estate investment and brokerage services. Indeed, Amlak has suggested that teams for some of these capability extensions are already in place, and businesses are now up and running.While we are cautiously optimistic about this, we believe there to be risks, as these "extension" plans have had mixed results in other markets.
Although in relative terms financial performance has disappointed, on an absolute basis FY2007 results are expected to be strongly ahead of expectations. Balance sheet growth has been around 10% ahead of expectations, and although net interest (equivalent) income has fallen short, this has been very much to do with the fact that Amlak has been building up its property portfolio, which has resulted in a shift from net interest to non-interest income. 2008 - strategy implementation
With 2007 being a year of strategy creation, 2008 will be about implementation. Geographically, Amlak has already opened a small Egyptian operation and a 22.5%-owned Saudi Arabian joint venture, but has also indicated aspirations in Morocco, Turkey, Syria and Pakistan. GCC and other Levant economies have also been mentioned. Indeed, Amlak has indicated that at some point it would expect the majority of its business to come from abroad. In 2008, we expect to see the first steps along that road, with Egypt and Saudi beginning to show material value.
Financially though, the key challenge is to demonstrate that the business plan works, by raising returns on equity towards the 20% level. We believe that it can and will make progress towards this target as spreads increase, and perhaps as securitization lowers the need for the current high level of capital. The strategy of diversifying along product lines may also bring significant cross-sell opportunity, and we expect to see increased non-interest income. recommendation While international ambitions are potentially value accretive, we find that Amlak is growing more slowly than the market or key competitors, and with inadequate returns, albeit driven in part by the low level of gearing. Overall, we feel it has put into place a strategy of geographical diversification before it has proven it can actually create shareholder value in its home market. The stock trades on a 2007 PBV of 3.7x and a 2007 PE ratio of 30.5x. While the new strategic direction may provide the missing value, we believe this is far from a foregone conclusion. We estimate a LT Fair Value of AED3.34, suggesting downside of 32%, based on which we have a LT recommendation of Reduce. In the short term we are concerned that the need for further capital could dent investor enthusiasm, also suggesting a ST recommendation of Reduce.
housing finance sector | amlak finance 53 54 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 /V()4439252.2 3.23 2.5 2.85 0.23 3.9 74.4% 1.81 3.2% 0.18 98.9% 4.4 12.1 2.5% 1.62 143.7% 0.22 13.2 0.59 3.1% 576.9% 0.20 17.2 2.8% 0.54 9.2% 0.59 Market Cap /Deposits 40.4 29.8% 0.41 0.54 134.7% 0.99 P/BV (x) 0.41 95.6% BVPS 0.18 Div. Yield DPS P/E (x) EPS Growth EPS (Normalized) EPS (AED) Est. Free Float Bloomberg/Reuters 52-Week High/Low Av. Mthly Liquidity(mn) Shares (mn) Mkt Value (Localmn) Last Ex-Div Date Data Stock
11-Dec-06 Neutral LT Rec. Neutral ST Rec.
11-Jan-07
11-Feb-07 [email protected] +971 43634009 CFA Raj Madha, 11-Mar-07
11-Apr-07
11-May-07 06 07 08 2009e 2008e 2007e 2006a
11-Jun-07 50% TAMWEEL:UH / TAML.DU AED7.49 /3.25 AED2,008 1,000 AED7,100 AED0.20 on11 April 2007 tamweel TFi au AED7.24 LT Fair Value : AED7.10 Current Price: 11-Jul-07
11-Aug-07
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11-Dec-07 oA 50 .%58 4.4% 19.3% 5.8% 24.2% 7.3% 24.1% 25.2% 35.0% 82.0% 20.9% N/A 20.7% 26.2% 758.3% N/A 97.4% 3.77% 40.0% 0.0% N/A 2.64% N/A N/A 3.29% RoAA* 50.0% 2.41% -12.3% N/A N/A N/A RoAE* 71.6% 3.13% N/A N/A Provisions Made/ Av. 95.0% Gross Loans(PTD-ann.) 1.76% 33.8% N/A Cost /Income 89.3% N/A 3.03% N/A 55.1% 166.6% Growth inNet Attributable Income(YoY) 0.32% 105.9% Growth inProvisions Made(YoY) 50.0% N/A N/A 167.1% 137.6% 668 32.9% Growth in Operating Expenses(YoY) N/A 178.6% 71.7% Growth inNon-Interest Income(YoY) 18.5% 121.9% 668 (4) N/A 45.4% Growth inNetInterest Income(YoY) 612 97.4% 103.3% Net Interest Margin* 22.5% 301.4% 612 Net Interest Spread* 209.9% 672 (1) 413 97.9% 19.2% Write-offs / Gross Loans 22.5% NPL Coverage Ratio 413 36.6% (226) NPLs / Gross 612 Loans 155 (0) 899 Growth inNPLs(YoY) - 293 851 Growth inNetLoans(YoY) (162) 50 - 413 449 Growth inDeposits(YoY) - 774 (108) Loans /Deposits 106 330 - 155 93 Capital Adequacy Ratio 512 - 521 Ratios (55) 89 137 Net Attributable Income 171 383 211 - Pretax Income N/A - Provisions for loanslosses 76 75 450 N/A Income Before Provisions 20 144 230 Total Operating Expenses 3,685 13,790 - - Other General 262 & Adm. Expenses 47 9,877 Salaries &employee related costs 179 3,247 2,000 2,014 Total BankingIncome 138 6,163 Total Non-Interest Income 1,814 222 1,000 17,475 1,517 Other Operating Income 1,643 67 income 1,382 Property 1,620 13,124 - 1,001 200 Trading &Investments Fees & 7,977 Commissions 1,067 657 9,547 212 Dividend Income - 2,298 Net Interest &IslamicReturns 589 3,262 13,139 7,182 Income Statement 1,314 1,987 Shareholders' Equity 8,757 227 4,940 Total Liabilities 765 1,521 Proposed Dividend 5,101 1,231 Other operating items 380 72 Capital MarketLiabilities 2,584 Customer deposits&IslamicFunding Total Assets Fixed & Other Assets Other Investments & Associates Loans &IslamicFinancing Cash &BankDeposits Balance Sheet December Year End(AEDmn) Sources: Tamweel, EFG-Hermesestimates Prices asat11December2007 *Annualized for data quarterly 025 5.%4.%9.2% 48.1% -51.5% 2002.5% uae research yearbook 2008 yearbook uae research 06 2007e 2006a / / / N/A N/A N/A N/A / / N/A N/A N/A N/A N/A N/A 2008e 2009e 2007: no pause for lack of a license 2008: delivering shareholder value uae research yearbook 2008
background Tamweel was established in 2002 by Dubai Islamic Bank as a mortgage finance company, but was partly spun off in February 2006 in a capital raising exercise.Tamweel is the largest housing finance company in the UAE, with a market share of around 30%.The company is now owned 20% by Dubai Islamic Bank and 22% by Istithmar, while strategic and founder investors account for a further 8%, leaving the remaining 50% open to the public. Foreign and GCC investors can own up to 40% of the company. Like Amlak,Tamweel has focused mostly on the primary market, building market intelligence and strong business relationships to leverage a good business platform. 2007 - strong growth
Recent growth has been strong at Tamweel.Total customer loans and commitments increased 49% in 2006, but have been accelerating steadily since 3Q2006. Mortgage loan and commitment growth reached 87% Y-o-Y in 3Q2007 and we expect it to peak in 4Q2007.
Returns have been weak at Tamweel, mostly due to its having negligible interest spreads.These spreads, however, were substantially due to rising interbank rates which leveled off in June 2006. Some mortgages are fixed rate until delivery of the property, then float thereafter. Consequently, recent dips in LIBOR have allowed recovery in spreads. In addition, a very strong 3Q2007 for origination, equivalent to 82% of the previous four quarters, led to strong fee income. With these two factors swinging in Tamweel's favor, ROE for 3Q2007 jumped to 28.7%.
Tamweel's diversification strategy is geographically adventurous, but product-wise relatively conservative. Tamweel is committed to Saudi Arabia and Egypt and has highlighted Turkey and India as addressable markets for 2008, while Pakistan and Morocco are longer- term ambitions. We regard these as offering long-term upside to existing growth numbers while potentially being supportive of the existing shorter-term numbers.The most important product diversification has been into land bank financing and investment. While we see this as very profitable, it may only be a bull market strategy, and we expect lower returns from 2010. 2008 - delivering returns
Going forward, we expect growth will remain strong, although dropping to a level of 20% by 2012 from 65% in 2008. This however is based on the assumption of a lack of a funding constraint, and there are many things that could cause a bump in the path ahead. One half of all funding is expected to come from corporate investment deposits.While growth has been exponential in the past, it is difficult to ascertain the actual demand for mortgage-backed deposits from institutional investors. Second, roughly a third of funding comes from securitization, and a key challenge for Tamweel in 2007 will be to demonstrate that the securitization program is back on its feet, unhurt by the problems facing the global asset-backed security market. In terms of geographical diversification, we would also expect to see some returns from the investments in Saudi Arabia and Egypt and progress on launching further markets.
For us as investors, however, the key question is how returns will be moving. Results in 3Q2007 were very much stronger than before, based on strong origination and a huge pick-up in spreads. While Tamweel has argued this was assisted by normalization of movements of LIBOR, we believe that this jump in spreads will not be sustainable, preferring instead to take the spread suggested by our more theoretical model of 250 basis points, leading to sustainable returns of around 18%. recommendation Overall, while the 2007 price-to-book ratio of 3.9x is not low, recent profitability improvements and stellar medium-term growth, albeit with an attendant dilutive capital raising, make this seem a little more reasonable. Taking into account revenue flows with a reasonable amount of visibility, we estimate a LT Fair Value of AED7.24, representing 2% upside to current prices. While we are concerned that we may have looked too far into the future to get this valuation, we have a ST/LT recommendation of Neutral by balancing this risk against international ambitions.
housing finance sector | tamweel 55 56 /V()3130292.8 1.26 2.9 1.21 0.11 3.0 1.18 3.1% 0.11 260.3% 3.1 3.1% 1.16 22.2 320.1% 0.09 400.1% 2.5% 24.6 - 0.16 593.8% 0.0% 32.2 0.14 11.2% Market Cap /Premiums 30.5% 22.0 0.11 -31.5% P/BV (x) 0.16 60% BVPS Div. Yield DPS P/E (x) EPS Growth EPS (AED) 2.0 2.5 3.0 3.5 4.0 4.5 Est. Free Float Bloomberg/Reuters 52-Week High/Low Av. Mthly Liquidity(mn) Shares (mn) Mkt Value (Localmn) Last Ex-Div Date Data Stock TRc Accumulate LT Rec. Accumulate ST Rec. 11-Dec-06
11-Jan-07
[email protected] +971 43634009 CFA Raj Madha, 11-Feb-07
11-Mar-07
11-Apr-07
11-May-07 2009e 2008e 2007e 2006a 21% IAIC UH/IAIC.DFM 4.04 /2.36 AED1,032.6 1,100 AED3,905 N/A islamic arabinsurancecompany (salama) islamic
11-Jun-07 AED3.62 LT Fair Value : AED3.55 Current Price:
11-Jul-07
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11-Dec-07 ioiyItrss4 04 40 (198) (43) 1,500 (161) (38) 40 251 2,870 1,220 1,440 (129) 1,390 976 2,575 (56) 219 40 1,199 (75) 1,336 93 2,360 34 186 658 (22) 199 190 1,023 41 1,297 2,050 232 2,870 120 108 186 120 664 737 34 145 163 1,272 Changes 2,575 inUnearnedPremiums 188 110 106 Reins. Premiums 186 Ceded 98 539 143 34 Gross Written Premiums 2,360 - 151 Income Statement 88 91 83 186 1,277 Total 433 Liab. &Equity 2,050 77 78 34 Minority Interests 1,050 94 - Shareholders Funds 1,105 64 67 312 Total Liabilities 40 976 Bank Finance 1,030 Other Payables and Accruals - 66 Insurance BalancesPayable 878 1,087 Unearned Premiums Reserve Outstanding Claims Reserve (6) 42 Total Assets 602 Goodwill Associates Fixed Assets Other Assets Total Investments Due from Related Parties Insurance Receivables Statutory Deposits Balance Sheet December Year End(AEDmn) oA94 .%64 6.5% 6.4% 5.5% 9.4% 11.2% 83.9% 30.1% 23.0% 54.0% 83.9% (5) 12.9% -30.5% 25.0% 11.2% 54.0% 23.7% 86.0% 43.7% 12.0% 48.4% 176 30.5% (4) 56.1% 9.6% 50.9% 20.3% Source: IAIC(salama), EFG-Hermes estimates 88.6% 9.5% 27.8% -31.5% (18) 54.3% 23.3% 158 181 RoAA 20.3% 9.6% (4) (4) RoAE14.9% 60.0% 351 45.3% Growth inNet Attributable 20.3% Income(YoY) (15) 121 9.6% - 163 Growth inEBT (YoY) 89 (3) 186 (5) 10 302 Growth inUnderwriting Profits (YoY) 21.2% (16) 13.1% Growth in GWP (YoY) 177 125 (144) Combined Ratio (2) 167 91 - 240 8 Expense2 Ratio-netcommissions (8) Expense1 Ratio-adminexpenses (117) 182 252 128 Loss Ratio (1) 99 280 - Ratios (539) 6 (94) Net Attributable Income 1,259 204 185 Minority Interest (433) 163 (343) (126) Net Incomebefore (86) Minorities 1,021 0 8 135 Earnings before Taxes andMinorities (312) Other Expense (279) Adjustment (106) 791 Finance Expense 109 Other (233) General & Adm. Expenses (223) (121) Total Revenue 561 Other Income& Adjustments (156) (63) Investment Income Life Insurance Surplus Net Underwriting Income Commissions Paid & Other Costs Changes in Outstanding Claims Net Claims Paid Premiums Earned Prices asat11December2007 uae research yearbook 2008 yearbook uae research 06 2007e 2006a 2008e 2009e 2007: solid growth 2008: moving the focus to returns uae research yearbook 2008
background Salama owns the first established retakaful (Islamic reinsurance) company, Best Re, which is based in Tunisia and serves clients primarily in the Middle East and South East Asia. In addition to the UAE, Salama has takaful operations in Saudi Arabia, Algeria, Egypt and Senegal as well as an important non-consolidated 30%-owned subsidiary in Saudi Arabia, IAIC Saudi Arabia. Best Re contributes to about 75% of Salama's gross written premiums and is biased in their portfolio towards fire reinsurance. The primary insurance businesses have predominantly vehicle insurance exposure, although they are generalist insurance operations. The individual businesses are allowed to operate semi-autonomously, although that may change in the future. 2007 - new growth opportunities
All markets in which Salama has takaful operations are characterized by high economic growth rates, low insurance penetration rates and recent extensive economic reforms. In addition, in many areas there have been legislative reforms aimed at formalizing insurance requirements. In particular, a new vehicle insurance law came into effect in Saudi Arabia in 2007 that requires all car owners to obtain, at the minimum, third-party liability insurance. Health insurance in the kingdom has followed a similar path, with new laws obliging large corporations to maintain health insurance for their expatriate employees, with medium and small companies eventually to follow. While these reforms are most pointed in Saudi Arabia, other governments are putting similar laws in place: Abu Dhabi has passed legislation on healthcare and Dubai expected to follow suit.
To take advantage of these trends, Salama this year launched its 30%-owned subsidiary in Saudi Arabia, where it plans to target all potential sales channels aggressively until it is clear which one will be dominant within the emergent market structure. Salama also launched a family takaful business in the UAE.While this is a very underpenetrated market, the lack of a fiscal incentive is likely to make it stay so. Nevertheless, an alliance with Tamweel to provide family takaful services to mortgage buyers is clearly important and was a key element of the very strong 3Q2007 premium growth. 2008 - delivering returns
Key targets for 2008 are not only to maintain the current level of growth, but also to start to move return on equity from its current value-neutral levels to levels that can justify the current large premium-to-book value. We believe there are two aspects to improving return on equity: i) to raise the level of gearing, and ii) to improve the level of working capital efficiency.
Although growth and a high payout ratio will eventually result in higher levels of gearing, we believe the company should take more urgent steps to improve its premiums-to-equity ratio. To this end the company undertook a largely symbolic buyback in 2007 and has undertaken to make several small acquisitions over the coming period.
As for working capital efficiency, the investment book at the moment is smaller than equity, meaning that working capital has failed to generate any positive liquidity for investment.The company has two strategies for addressing this: i) to move away from the structurally inefficient segments of the North African retakaful market, and ii) to manage working capital more aggressively going forward. recommendation Both the retakaful and takaful markets are expected to grow at a CAGR of 20% over the next three to five years. With our forecast of strong growth, improvements in the cash cycle and capital efficiency over the medium term, Salama looks well placed for the future. Furthermore, Salama is at a nexus with regard to strategic development in the sector, being both an attractive target and a company which is well positioned for acquisitions and greenfield investments. The stock trades at a premium to its competitors, but at a small discount to our estimated LT Fair Value of AED3.62, indicating a 2% premium to the current share price. We have a ST/LT Accumulate recommendation on the stock.
insurance sector | salama 57 telecom sector
highlights of 2007: undaunted growth
UAE Telecom Market Indicators 2006a 2007e 2008e 2009e 2010e 2011e 2012e 2013e
Population (mn) 4.5 4.7 5.2 5.7 6.0 6.4 6.7 6.9 Mobile Market Indicators Mobile Addressable Mkt. (mn) 6.1 6.5 7.2 8.0 8.5 9.0 9.4 9.7 Additions (000's) 986 1,627 732 439 316 334 351 359 Subscribers (000's) 5,520 7,147 7,879 8,318 8,635 8,969 9,320 9,679 Penetration to Addressable 91% 109% 109% 105% 101% 100% 99% 100% Penetration Rate 123% 151% 153% 147% 143% 140% 139% 141% Etisalat Etisalat Subscribers (000's) 5,520 6,339 6,375 6,234 6,027 5,962 6,027 6,198 Etisalat Market Share 100% 89% 81% 75% 70% 66% 65% 64% du du Subscribers-Active (000's) 808 1,504 2,084 2,607 3,007 3,293 3,482 du Market Share-Active 11% 19% 25% 30% 34% 35% 36% du Subscribers-Reported (000's) 1,100 1,580 2,147 2,633 3,007 3,293 3,482 du Market Share-Reported 15% 20% 26% 30% 34% 35% 36% Fixed Line Market Indicators Fixed Line Addressable Mkt. (mn) 2.0 2.1 2.3 2.5 2.7 2.83.0 3.0 Additions (000's) 73.7 77.4 100.7 120.8132.9 140.8 145.1 148.0 Subscribers (000's) 1,311 1,388 1,489 1,610 1,743 1,883 2,028 2,176 Penetration to Addressable 66% 67% 66% 65% 65% 67% 69% 72% Penetration Rate 29% 29% 29% 28% 29% 29% 30% 32% Etisalat Etisalat Subscribers (000's) 1,285 1,331 1,376 1,427 1,487 1,547 1,614 1,685 Etisalat Market Share 98% 96% 92% 89% 85% 82% 80% 77% du du Subscribers (000's) 26 57 113 182 256 336 414 491 du Market Share 2% 4% 8% 11% 15% 18% 20% 23% Source: Etisalat, du and EFG-Hermes estimates
The UAE's telecom sector, benefiting from the booming economy and one of the region's fastest expanding populations, delivered strong growth in the first nine months of 2007.
Perhaps the most important event in the UAE telecom sector in 2007 was the entrance of a second integrated operator, Emirates Integrated Telecommunications Company (EITC), commercially known as du, which started operations on 11 February, ending Etisalat's 30-year monopoly.
Fig 1: Mobile Penetration Rates Across MENA - (End Sep. 07) Fig 2: Fixed-Line Penetration Rates Across MENA - (End Sep. 07) 160% 35%
140% 30% 120% 25% 100% 20% 80% 15% 60% 10% 40% 20% 5% 0% 0% Iraq UAE UAE Syria Syria Libya Egypt Egypt Qatar Qatar Saudi Saudi Oman Oman Jordan Jordan Yemen Yemen Kuwait Kuwait Tunisia Tunisia Algeria Algeria Bahrain Bahrain Lebanon Lebanon Morocco Morocco Source: Etisalat, company reports
58 uae research yearbook 2008 2007: undaunted growth 2008: high and rising uae research yearbook 2008
the mobile market The mobile market unexpectedly surged in the first nine months of 2007, with the market adding 1.6 million subscribers versus fewer than 1.0 million for the whole of 2006. du had the highest share of additions, gaining 882,000 subscribers, while Etisalat added 670,000. We estimate that 80% of du's reported additions are active. The entrance of du drove the penetration rate to 151% as of end- September. As we had expected, this exceeded the size of the addressable market, which we estimate at 140% to 145% of the population. If we use our estimate of active subscribers, the UAE's mobile penetration rate as of end-September drops to 147%. Although the entrance of competition was a major driver of this strong mobile market growth, we believe the rapid expansion of the country's population was also important.
We were right in expecting that competition in the UAE market would not be fought with price cuts. Rather than slash headline tariffs and start a price war with Etisalat, du, which covers 85% of the UAE population with its own network and the rest through a national roaming agreement with Etisalat, focused more on market segmentation and promotional offers to gain market share.
Table 3: Etisalat and du's Mobile Tariffs (AED) du Etisalat Prepaid Connection 155 165 Annual Fees 100 100 Postpaid Connection 125 185 Monthly Fees 30 20 Prepaid & Postpaid Tariffs To Mobile and FL 0.30 0.30 To International 2.282.30
Source: Etisalat, du
Etisalat's quarterly ARPUs continued to grow Q-o-Q, driven by rising usage and relatively stable prices.We estimate Etisalat's monthly ARPU for 9M2007 at AED193 (USD53), versus a monthly ARPU for du during its first months of operation (February-September) of AED129 (USD35). We expect a relatively stable/rising ARPU's for both operators, given the strong economic backdrop and rational competition.
Fig 4: Quarterly Subscriber Additions for du and Etisalat (Active) Fig 5: Etisalat's and du Quarterly ARPU (AED) Etisalat ARPUs trending upward. The 3Q 600 Etisalat du 200 du decline is due to the 190 seasonality factor 500 180 170 400 63% 56% 160 300 28% 150 140 200 130 72% 38% 44% 120 100 110 0 100 1Q06a 2Q06a 3Q06a 4Q06a 1Q07a 2Q07a 3Q07a 1Q06a 2Q06a 3Q06a 4Q06a 1Q07a 2Q07a 3Q07a
Source: Etisalat, du and EFG-Hermes estimates Source: EFG-Hermes estimates fixed-line market We estimate a fixed-line penetration rate of 30% as of end-September, up from 29% in December 2006.The market added 70,700 new lines in the first nine months of 2007, implying Y-o-Y growth of 64%. Etisalat, at 67%, representing 1.32 million lines, had the highest share of additions. du added the remaining 33%, increasing its market to 3% as of end-September.
In an interesting and expected development, the regulatory authority in August began allowing carrier-select in the UAE, a service that lets fixed-line users to chose between the two existing operators when making a call. For international calls, du is matching Etisalat's off-peak international tariffs throughout the entire day, in addition to providing per-second billing.We expect this to boost du's revenue at the expense, of course, of Etisalat.
telecom sector 59 telecom sector
highlights for 2008 and beyond
With mobile and fixed-line penetration rates of 151% and 30%, both the highest in the Middle East and North Africa (MENA), we believe that population will be the main driver of telecommunication growth. We forecast that the UAE's population will grow at a 2007-12 CAGR of 7.3%. mobile market We expect the mobile penetration rate to continue to exceed the size of our estimated addressable market over the next two years, then to decline to a level equal to it. We project that mobile subscriber additions will begin to slow, with the expanding population driving most of the growth. For 2008, we expect subscribers to grow by 10.2%, up from the 6.7% we had previously forecast.This is less than the 29.5% growth that we expect for 2007.
We expect mobile number portability (MNP) services to be introduced in the UAE in 2008 and that du will be a net receiver of ported numbers for five years once it is. We expect du to continue capturing a higher share of net additions over the next two years, increasing its market share to 25% in 2009. Afterwards, we expect the share of new additions to stabilize at 50:50 between du and Etisalat. Over the long term, we expect Etisalat's market share to stabilize at 64% and du's at 36%.
Fig 6: Historical & Forecast Mobile Subscribers Fig 7: Etisalat & du Historical and Forecast Mobile and Penetration Rate in the UAE Market Share in the UAE
(mn) (mn) 1.2 10.0 Mobile Subs. (LHS) Mobile Penetr. Rate (RHS) 180% Etisalat Mkt. Share 9.0 100% du Mkt. Share 160% 1.0 8.0 89% 140% 81% 7.0 0.8 75% 120% 70% 6.0 66% 65% 100% 5.0 0.6 80% 4.0 60% 0.4 34% 35% 3.0 30% 25% 2.0 40% 19% 0.2 11% 1.0 20% 0 0% 0 2006a 2007e 2008e 2009e 2010e 2011e 2012e 2006a 2007e 2008e 2009e 2010e 2011e 2012e
Source: Etisalat, EFG-Hermes estimates Source: Etisalat, du and EFG-Hermes estimates fixed-line market We expect the fixed-line penetration rate, which has been stable at the 30% level since 2002, to start increasing over the next five years. We believe that the introduction of triple-play services, expected in late 2008 or early 2009, will boost fixed-line penetration, especially if it results, as we expect, in a reduction in broadband prices. du has awarded a contract to Alcatel-Lucent to provide internet protocol television (IPTV), including video-on-demand services.
We believe that both operators will focus on value-added services and other interesting value proposals to customers that will increase spending on services based on fixed lines.
We project fixed-line subscribers will grow at a five-year (2007-12) CAGR of 7.9%, slightly higher than the growth in population for the same period.We forecast that the fixed-line penetration rate will climb to 34% in 2015 then stabilize thereafter.Throughout our forecast horizon, we expect Etisalat's market share to decline gradually, then stabilize at 75%.
uae research yearbook 2008 60 2007: undaunted growth 2008: high and rising uae research yearbook 2008
Fig 8: Historical & Forecast Fixed-Line Subscribers Fig 9: Etisalat & du Fixed-Line Market Share and Penetration Rate in the UAE Estimates in the UAE (mn) FL Subs. (LHS) 2.5 32% FL Penetr. Rate (RHS) 120% du Mkt. Share Etisalat Mkt. Share 98% 96% 31% 92% 2.0 100% 89% 85% 82% 30% 80% 80% 1.5 29% 60% 1.0 28% 27% 40% 18% 20% 0.5 15% 11% 26% 20% 8% 2% 4% 0 25% 0% 2006a 2007e 2008e 2009e 2010e 2011e 2012e 2006a 2007e 2008e 2009e 2010e 2011e 2012e
Source: Etisalat, EFG-Hermes estimates Source: Etisalat, du and EFG-Hermes estimates
Wael Ziada Marise Ananian +20 2 33 32 1154 +20 2 33 32 1152 telecom sector 61 [email protected] [email protected] etisalat
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 23.6 Assets LT Rec. Buy LT Fair Value : AED 31.3 Cash and Time Deposits 10,304 9,401 11,174 13,595 Receivables 3,127 3,724 5,2585,936 Other Current Assets 122 261 368478 Net plant 8,495 10,380 12,086 13,187 Stock Data Intangibles & Others 23,859 24,690 24,537 24,865 Last Ex-Div Date AED0.25 on 18 July 07 Liabilities and Equity Mkt Value (Local mn) AED117,794 Payables 1,807 1,974 2,395 3,131 Shares (mn) 4,991 Other Current Liabilities 10,210 10,236 10,414 9,828 Av. Mthly Liquidity (mn) AED501 Dividends Payable 1,588 1,736 2,079 2,288 52-Week High/Low AED24.5/14.1 LT Debt 6,981 6,859 9,208 11,594 Bloomberg/Reuters ETISALAT HU/ETEL.AD Minority Interest 2,2082,5872,770 3,113 Est. Free Float 40.0% Other LT Liabilities 3,9282,962 1,997 1,032 Net Worth 19,187 22,102 24,560 27,077 Balance Sheet Total 45,908 48,457 53,423 58,061 (AED) 2006a 2007e 2008e 2009e Income Statement EPS (Reported) 1.17 1.481.70 1.83 Total Revenue 18,714 24,283 28,546 30,699 EPS (Attrib.) 1.17 1.481.70 1.83 EPS (Attrib.) Growth 38% 26% 15% 8% EBITDA 12,534 15,457 17,452 17,964 P/E (Attrib.) 20.1 15.9 13.9 12.9 Depreciation and Amortization (1,391) (2,086) (2,698) (2,977) EBIT 11,143 13,370 14,753 14,986 DPS 0.55 0.70 0.83 0.92 Net Interest Income (Expenses) 214.0 (207.9) (618.1) (936.8) Dividend Yield 2.3% 2.9% 3.5% 3.9% Other Income (Expenses) 45.6 158.0 160.0 158.5 BVPS 3.84 4.43 4.92 5.42 Income from Associates 267.0 655.7 998.1 1,183.0 P/BV 6.1 5.3 4.84.4 Net Profit before Minority Interest 11,670 13,976 15,293 15,391 Minority Interest 49.6 796.7 721.2 661.8 CFPS (Operating CF) 1.85 1.82 1.78 2.09 P/CF 12.813.0 13.3 11.3 Net Profit before Royalty Fees 11,719 14,773 16,014 16,053 FCF Yield 6.6% 4.7% 4.5% 6.0% Royalty Fees (5,860) (7,386) (7,527) (6,903) Net Income 5,860 7,386 8,488 9,150 EV/Sub* 9,922 6,620 5,084 4,293 Net Attributable Income 5,860 7,386 8,488 9,150 EV/Revenues 6.12 4.75 4.06 3.77 EV/EBITDA* 9.13 7.46 6.64 6.45 Cash Flow Statement EV/IC 6.33 5.20 4.57 4.11 Cash Op. Profit after Tax 6,675 8,070 9,925 11,061 Net Debt (cash) /Mkt Cap -3% -2% -2% -2% Cash Flow after change in WC 9,229 9,064 8,883 10,424 *Proportionate Capital Expenditure (1,407) (3,546) (3,632) (3,307) Free Cash Flow 7,823 5,518 5,251 7,117 Non-op. Cash Flow (12,201) (1,084) 876.5 576.1 26 Cash Flow before Financing (4,378) 4,434 6,127 7,693 24 Net Financing 5,024 (5,337) (4,354) (5,273) Change in Cash 645.2 (903.2) 1,773 2,420 22 Key Forecast Drivers 20 Local Subs (Fixed-Line and Mobile) 6.81 7.67 7.75 7.66 Regional Proportionate Subs. 4.73 9.74 15.03 19.31 18 Total Proportionate Subs. 11.54 17.41 22.7826.97 16 Revenue Growth 20.2% 29.8% 17.6% 7.5% Capex/Sales 7.5% 14.6% 12.7% 10.8% 14 EBITDA Margin 67.0% 63.7% 61.1% 58.5% 12 Effective Tax Rate (Royalty payment) 50.0% 50.0% 47.0% 43.0% Fianancial Indicators ROE 30.5% 33.4% 34.6% 33.8% 11-Jun-07 11-Feb-07 11-Aug-07 11-Dec-06 11-Dec-07 11-Jan-07 11-Apr-07 11-Mar-07 11-May-07 11-Sep-07 11-Jul-07 11-Nov-07 11-Oct-07 ROAIC 42.2% 140.0% 129.5% 115.9% Dividend Payout Ratio 46.5% 47.0% 49.0% 50.0% Net Debt (Cash) (3,323) (2,542) (1,966) (2,001) Net Debt (Cash)/BV -17.3% -11.5% -8.0% -7.4% Net Debt/EBITDA (0.27) (0.16) (0.11) (0.11) EBITDA/Net Interest Expense 58.6 (74.3) (28.2) (19.2) Prices as at 11 December 2007 Source: Etisalat, EFG-Hermes estimates
Marise Ananian 62 +20 2 33 32 1152 uae research yearbook 2008 [email protected] 2007: home market is still the value driver 2008: non-uae operations start to contribute uae research yearbook 2008
background Etisalat, the UAE's incumbent, is a full-service telecom service provider owned 60% by the Abu Dhabi government and 40% as free- float shares on the Abu Dhabi stock exchange. Etisalat lost its monopoly of fixed-line and mobile services in the UAE in February with the entrance of Emirates Integrated Telecommunications Company (EITC), also known as du. Etisalat's footprint extends to 16 countries following its recently announced acquisition in Indonesia, and its total population under license is 767 million, with an implied penetration rate of 29%.
Etisalat owns 35% of Saudi Arabia's second mobile operator, Etihad Etisalat, commercially know as Mobily. By end-September 2007, after two years of operation, Mobily had grabbed a 33% market share from the incumbent Saudi Telecom Company (STC). Etisalat has a 26% stake in Pakistan Telecommunications Company Limited (PTCL), the incumbent Pakistani operator. As of end-September, PTCL had a fixed-line market share of 97% and mobile market share of 22% through its 100%-owned mobile subsidiary Ufone, the second largest mobile operator in Pakistan by subscriber market share. Etisalat Egypt, 66% owned by Etisalat, in May 2007 began operations in Egypt, where it offered 3G mobile services for the first time. After only six months, Etisalat Egypt had captured around 2.0 million subscribers, giving it a market share of 7% as of end-September. Etisalat also has stakes in Zantel, the fourth mobile operator in Tanzania, and Canartel, the second fixed-line operator in Sudan. 2007 - uae operations drives results
Etisalat continued its strong subscriber growth in the UAE despite the entrance of du in February, with mobile subscribers climbing to 6.19 million as of end-September, in line with our estimate. Fixed-line subscriber growth, at 1.32 million, was also in line with our estimates. Etisalat reported strong 9M2007 results, with gross consolidated revenue growing by 29.8% Y-o-Y to AED17,571 million, EBITDA by 24.6% to AED11,692 million and net profit by 26.2% to AED5,533 million. We estimate that Etisalat Egypt's operations contributed less than 1% of Etisalat's 9M2007 consolidated revenue. Mobily and PTCL, both consolidated under the equity method, contributed AED360 million to Etisalat's 9M2007 earnings. We forecast full year 2007 gross revenue of AED24.3 billion, 29.8% higher than 2006. We believe revenue growth in 4Q2007 will mostly be driven by the UAE operation, with the contribution from the Egyptian operation increasing to 3.2%.
In August 2007, Etisalat Afghanistan, the country's fourth mobile operator, owned 100% by Etisalat, started operations in five of Afghanistan's main cities. In early 2007, Etisalat agreed to buy 40% of Nigeria's fifth mobile license from UAE-based Mubadala Development Company for USD400 million and to become the operating partner. Etisalat plans to start the Nigerian operation in early 2008. Etisalat also increased its stake in Atlantique Telecom, which owns operators in six African countries, to 70% from 50%. Finally in December, Etisalat announced it will acquire 16% of Indonesia-based mobile operator Excelcomindo for USD438 million. 2008 - expansions to start paying-off
Nigeria, which will be proportionally consolidated, will begin contributing to the company's total revenue by the end of 2008.We expect the non-UAE operations (Egypt, Afghanistan, Nigeria) to contribute 9% of Etisalat's 2008 consolidated revenue. We forecast that the UAE operation will remain Etisalat's main revenue generator, contributing more than 75% of consolidated gross revenue in 2015 and after. The start-up nature of the Egyptian, Afghan and Nigerian operations, which are expected to generate losses at the EBITDA level, has a dilutive impact on Etisalat's consolidated EBITDA. We forecast consolidated EBITDA to grow by 13% in 2008, down from 23% in 2007. We forecast the EBITDA margin will decline to 61.1% in 2008 from 63.7% in 2007 and 67.0% in 2006. We forecast that consolidated earnings will grow faster than EBITDA, due mostly to the contribution of the Saudi and Pakistani operations and to our assumption of a decline in royalty payments. We forecast that Etisalat's consolidated net profit will grow 15% in 2008. recommendation We have a ST/LT Buy recommendation on Etisalat with an estimated Fair Value of AED31.3. We believe Etisalat's attractive valuation and its mix of value and growth, with the value coming from its mature UAE operation and the subscriber growth from the fast-growing operations in Egypt, Pakistan, Saudi Arabia, Nigeria and other African markets, make it one of the region's more attractive telecom exposures. With the bulk of its value generated from the relatively mature UAE operation, the downside risk to valuation from highly competitive and fast growing regional operations is, in our view, relatively limited.
telecom sector | etisalat 63 emirates integrated telecom. Co. (du)
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Accumulate Current Price: AED 6.1 LT Rec. Accumulate LT Fair Value : AED 7.0 Assets Cash and Time Deposits 1,646 93 281 234 Receivables 249 450 530 573 Other Current Assets 142 137 158170 Net plant 1,122 2,783 4,129 5,112 Stock Data Last Ex-Div Date N/A Intangibles & Others 975 1,037 985 932 Mkt Value (Local mn) AED24,400 Liabilities and Equity Shares (mn) 4,000 ST Debt - - - - Av. Mthly Liquidity (mn) AED736.5 Payables 540 1,854 2,045 2,013 52-Week High/Low AED7.1/4.6 LT Debt - - 2,000 2,700 Bloomberg/Reuters DU UH/DU.DU Other LT Liabilities 204 173 138111 Est. Free Float 20.0% Net Worth 3,391 2,473 1,899 2,197 Balance Sheet Total 4,135 4,500 6,082 7,020 Income Statement (AED) 2006a 2007e 2008e 2009e Wireless Revenue - 801.4 1,754 2,734 EPS (Reported) (0.15) (0.23) (0.14) 0.07 Fixed Line Revenue 434.0 686.8 1,032 1,476 EPS (Attrib.) (AED) (0.15) (0.23)(0.14) 0.07 EPS (Attrib.) Growth N/A N/M N/M N/M Total Revenue 434.0 1,488 2,786 4,210 P/E (Attrib.) N/M N/M N/M 81.99 EBITDA (672.7) (767.4) (199.0) 1,016 Depreciation and Amortization (82.5) (199.7) (319.4) (423.2) DPS ---- Dividend Yield 0.0% 0.0% 0.0% 0.0% EBIT (755.2) (967.2) (325.6) 787.2 Net Interest Income (Expense) 146.3 45.0 (55.3) (134.6) BVPS 0.85 0.62 0.47 0.55 Other Income (Expense) - - - - P/BV 7.2 9.9 12.811.1 Net Income before Taxes (608.9) (918.2) (573.8) 457.8 CFPS (Operating CF) (0.07) 0.09 (0.03) 0.19 Income Taxes (Royalty Payment) - - - (160.2) P/CF (82.1) 69.5 (222.1) 31.7 Net Income (608.9) (918.2) (573.8) 297.6 FCF Yield -9.6% -5.9% -7.4% -3.1% Net Attributable Income (608.9) (918.2) (573.8) 297.6 EV/Sub 883,812 28,102 16,162 11,195 Cash Flow Statement EV/Revenues 52.42 16.33 9.37 6.38 Cash Operating Profit after Tax (415.5) (767.4) (199.0) 855.4 EV/EBITDA N/M N/M N/M 26.45 Cash Flow after Change in WC (297.3) 350.9 (109.8) 768.9 EV/IC 6.71 8.29 8.20 6.11 Net Debt (Cash) /Mkt Cap -6.7% -0.4% 7.0% 10.1% Capital Expenditure (2,056) (1,807) (1,613) (1,354) Free Cash Flow (2,353) (1,487) (1,757) (612.4) Non-operating Cash Flow - - - - Cash Flow before Financing (2,353) (1,487) (1,757) (612.4) 7.8 Net Financing 4,000 45.0 1,945 565.4 7.4 Change in Cash 1,647 (1,442) 187.6 (47.0) 7.0 Key Forecast Drivers 6.6 Fixed Line Subs (000's) 25.7 56.7 111.6 170.8 6.2 Mobile Subs (000's) - 0.1 0.2 0.3 5.8 Total Subs (000's) 25.7 56.8 111.8 171.1 5.4 Revenue Growth N/A 242.9% 87.2% 51.1% Capex/Sales 473.7% 121.4% 57.9% 32.2% 5.0 EBITDA Margin -155.0% -51.6% -7.1% 24.1% 4.6 Effective Tax Rate (Royalty payment) 0% 0% 0% 35% 4.2 Fianancial Indicators ROE -18.0% -37.1% -30.2% 13.5% ROAIC -22.3% -16.5% -8.1% 6.7% 11-Jul-07 11-Apr-07 11-Oct-07 11-Jun-07 11-Feb-07 11-Aug-07 11-Dec-07 11-Dec-06 11-Jan-07 11-Sep-07 11-Mar-07 11-Nov-07 11-May-07 Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% Net Debt (Cash) (1,646) (93) 1,719 2,466 Net Debt (Cash)/BV -48.5% -3.8% 90.5% 112.3% Net Debt/EBITDA 2.45 0.12 (8.64) 2.43 EBITDA/Net Interest Expense (4.6) (17.1) 3.6 (7.5) Prices as at 11 December 2007 Source: du, EFG-Hermes estimates
Marise Ananian 64 +20 2 33 32 1152 uae research yearbook 2008 [email protected] 2007: successful launch 2008: on the right track uae research yearbook 2008
background Emirates Integrated Telecommunications Company (EITC), commercially known as du, is the UAE's second licensed telecom operator. It was granted a full-fledged telecommunication license in May 2005 to offer mobile, fixed-line and internet services.
In April 2006, the original shareholders (the UAE federal government and two wholly owned subsidiaries: Mubadala Development Company and TECOM Investments) sold a 20% stake, or 800 million shares, in an initial public offering (IPO). Following the IPO, the government retains an 80% stake held directly and indirectly. du is listed on the Dubai Financial Market (DFM). du began offering both fixed-line and mobile services on 11 February 2007. Its mobile network now covers almost 85% of the population, while the remainder is covered through a national roaming agreement with Etisalat. 2007 - better-than-expected subscriber uptake
In its seven months of operations, du captured a 12.5% market share, with 882,000 reported subscribers as of end-September. As expected, its entry packages and promotional offers during its launch phase increased the number of inactive subscribers, which we estimate represent around 20% of the total. This implies an active subscriber base for du of around 706,000 mobile subscribers as of end-September, giving it an active subscriber market share of 10.2%. We estimate the average revenue per user (ARPU) over the whole of the seven months of operation was AED129 (USD35). It should be borne in mind, however, that our calculation of ARPU includes both in-bound roaming revenue and wholesale revenue.These inflate the ARPU above what it would be if calculated solely on subscriber usage.
The number of fixed-line subscribers rose 35,780 as of end-September, implying a market share of 2.6%. Following approval by the regulator, du introduced carrier-select in the UAE in August, a service that allows Etisalat's fixed-line users to select du's network when making national or international calls. For international calls, du is matching Etisalat's off-peak international tariffs throughout the entire day, in addition to offering per-second billing. du's 3Q2007 revenue grew 36.4% Q-o-Q to AED412 million. Mobile revenue, which constituted 61% of total revenue, jumped 65% Q-o-Q. Fixed-line and broadcasting revenue rose 7.3% from 2Q2007 to AED171 million. We expect 4Q2007 revenue to increase 43% Q-o-Q to AED591 million, driven by 46% growth in mobile revenue, which we believe will constitute 62% of total revenue in 2007, rising to 63% in 2008. 2008 - another year of positive surprises
We forecast du's reported mobile subscribers will climb to 1.1 million by the end of the year. However, we estimate active subscribers will be 20% less, or 808,000. du announced in mid-November that it had reached the one million subscriber mark, helped by its new promotion where the customer pays AED55 to get a mobile line that includes AED54 worth of free minutes. Our subscriber forecast for du implies an active subscriber market share of 11.3% at end-2007.
We expect du's mobile subscribers to increase at a five-year CAGR of 32% to 3.3 million in 2012, implying 35% market share. Over the long term, we expect its market share to stabilize at 36%. We expect du's market share to increase gradually as it continues to capture the higher share of net additions in the market in 2008 and 2009.
We forecast du's fixed-line subscribers will grow at a 2007-12 CAGR of 43.5% to 414,000 by 2012, with a market share of 20%. Over the long run, we expect du's fixed-line market share to stabilize at 21%. We expect du to break even on the EBITDA level in early 2009. Our forecasts imply an EBITDA margin in 2009 of 24%, rising to 45% in 2012. recommendation We have a ST/LT Accumulate recommendation on du, with a Long-Term Fair Value estimate of AED7.0 that we derive using a discounted cash flow (DCF). Our Long-Term Fair Value estimate is 15% above the current market price of AED6.1. Etisalat, with its well entrenched local operation, exposure to other high-growth markets and its relatively attractive valuation, nonetheless remains our top pick in the UAE telecom market.
telecom sector | du 65 real estate sector
recent developments in the dubai residential real estate sector
There were a number of indications in 2007 that Dubai's residential property market is maturing: i) prices rose at a relatively steady and slower pace, ii) the supply of new property lagged behind demand, iii) important legal improvements were introduced, iv) a greater proportion of end users entered the market, and v) activity in the secondary property market increased.
Key Developments During 2007
- Our-in house price index rose 18.7% over the period Jan-Nov 2007 Contained price - This compares with an estimated +20% in 2006 (12 months) increases - The index for villas rose 21.4%, while apartments rose 18.6%
- Supply lagging behind demand for a third year running is allowing the Supply lag trend of price appreciation to remain continues - Delay in new supply onslaught prolongs pressure on rental market
- Series of legal improvements which include establishment of i) a Improving legal brokers law, ii) escrow law and iii) real estate regulatory body (RERA) structure - Instrumental in adding much needed confidence
- Increased proportion of end users (buy rather than rent) Changing buyer - International demand continues to be strong profile - Mortgage financing increasing level of demand
- Skilled and unskilled labour shortages, coupled with rising cost of Construction Cost construction is putting pressure on developers Inflation - Higher costs and inability to secure enough labour could further delay project deliveries rental market An excess of demand over supply and a steady inflow of expatriates have strained the city's housing stock and pushed up rental rates. A rent cap of 7% for 2007 provided some relief to tenants: rental rates increased 16.1% in the 11 months to end-November compared to 30% over the whole of 2006. Rents are at an all time high, and further increases could render the city economically uncompetitive for many. Other government measures, including other types of rent control and the establishment of price/rent indices to set rental rates by location, are likely to put downward pressure on rents in 2008, while certain prestigious or desirable locations remain expensive. We believe, however, that one of the key forces pushing rental rates down will be a robust surge in supply. residential property market outlook supply A key theme in 2007 has been the slower-than-expected pace of project handovers and subsequent staggered delivery schedule. For our analysis, we have divided supply into two categories (see our 24 September 2007 note "Hot Market Begins to Cool"): i) actual supply, which takes into account delivery delays and supply lags, and ii) expected supply spillover, which is those delayed units delivered over the subsequent two years. We now expect 25,000 units to be delivered in 2007, 64,000 in 2008 and 68,000 in 2009. This revised methodology has shifted our peak supply year to 2009 from 2008, which was projected in our December 2006 market study. demand The addressable market of potential homebuyers further expanded in 2007, due both to expanding foreign interest in Dubai as a "destination" city and to an increase in the number of expatriate residents. We estimate that Dubai's population will rise to almost 2.0 million in 2010 from the current (2007e) level of 1.6 million people, implying a CAGR of 9.0%. We now estimate resident demand of 40,000 to 45,000 units per annum (based on expected natural population increases as well as expected immigration), with international (non-resident) demand of c13,000 units in 2007.
66 uae research yearbook 2008 2007: year of delays 2008: fundamentally strong uae research yearbook 2008
Fig 1: Expected Annual Supply 2007e-2012e Fig 2: Expected Annual Demand 2007e-2012e
Number of Housing Units Number of Housing Units Demanded Spillover from 2 Years Earlier 80,000 70,000 Spilover from a Year Earlier Resident Demand for Housing (Locals & Expatriates) Supply Not Subject to Spillover Potential International Demand 70,000 60,000 60,000 50,000 50,000 40,000 40,000 30,000 30,000 20,000 20,000 10,000 10,000 0 0 2007e 2008e 2009e 2010e 2011e 2012e 2006e 2007e 2008e 2009e 2010e 2011e 2012e
Source: EFG-Hermes estimates market outlook We believe that the delay in property handovers seen in 2007 will likely continue over the next 12 to 18 months, such that the peak year of supply, and hence a price correction, will most likely occur in 2009. While we believe there will be excess supply in 2008, we see this being absorbed by the pent-up demand of earlier years (2005-2007). The weakening of the AED (in tandem with USD weakness) and tightened local real estate regulations is likely to boost international demand for UAE property. The current lack of confidence in most developed countries, however, could eventually spread to emerging markets. This adds an element of uncertainty to our demand forecast, since it could potentially cause property prices to decline sooner than expected. extent of forecast price correction In September 2007, we forecast a rise in average prices of 10% to 15% for 2007. Our in-house price index indicates that overall asking prices for both villas and apartments rose 18.7% in the 11 months to end-November 2007, which is above our expectations.This mostly reflects the strong price increase of units in iconic projects such as Burj Dubai, DIFC and Palm Jumeirah, but may also reflect a recent increase in money flowing into emerging markets in general. For 2008, we forecast that prices will rise by 5% to 10% and that they will peak in 2H2008 as more supply hits the market. We expect prices will begin declining in 2009 once supply peaks, with a cumulative decline of 15% to 20% between 2009 and 2011. Since villas are expected to account for only 10% of total new housing units, we do not expect to see meaningful declines in prices in this segment.We also expect certain key developments, such as Burj Dubai and DIFC, which are in central business locations, to hold on to their value in the face of a market correction. recent developments in the dubai commercial real estate sector
Finding good office space in the city remains arduous, with companies often settling for less desirable locations, renting temporary space in villas, setting up branches or smaller offices or buying office space rather than leasing. In fact, we estimate commercial occupancy rates of around 99% in both traditional and newer areas of Dubai. We estimate that office rents have risen by almost 40% YTD in both old and new areas of Dubai due to fast-growing demand. Newer areas of Dubai have become centers of commerce, a trend that explains why rental rate increases are not slowing in these locations. Selling prices for off-plan developments in the DIFC, Burj Dubai and offices in the JLT have increased by approximately 23% over the past 11 months. This is due to: i) the desirability of their location, and ii) expectations of strong yields based on current off-plan prices and expected future rents.
Fig 3: Average Commercial Rents 2005-2007 Fig 4: Commercial Freehold Selling Prices Price per Square Foot (AED) YTD Price Increase (%) Rent/ sq ft. - AED Rate Increase (%) 4,000 2006 2007 YTD % Increase 60% 300 Average Rent Rental Rate Increase 50% 3,500 50% 250 40% 3,000 40% 200 2,500 30% 2,000 30% 150 1,500 20% 20% 100 1,000 10% 10% 50 500 0 0% 0 0% DIFC Business TECOM JLT Silicon Burj Dubai 2005 2006 2007 Bay Oasis Source: EFG-Hermes estimates real estate sector 67 real estate sector
Dubai is one of the most expensive business cities globally, with an average rent of USD98 per square foot, almost as high as New York. This compares to USD106 in Hong Kong, USD127 in Paris, and USD189 in Mumbai or USD68 in Abu Dhabi.The changes in various cities, especially "emerging" destinations, over the last 12 months were pronounced. Table 5 suggests that further upside is possible, even if locations as Mumbai or Moscow can be viewed as closer to a potential peak than Dubai at this stage.
Table 5: Global Office Rent Comparison Location USD / Sqf Change 12m
Mumbai 189.5 55%
London (City) 180.8 14%
Moscow 180.1 65%
Paris 127.3 14%
Hong Kong 106.3 31%
Singapore 102.4 83%
New York (midtown) 100.823%
Dubai 98.3 19%
Zurich 74.9 12%
Abu Dhabi 68.1 47%
Source: CB Richard Ellis commercial property outlook In contrast to North America and Western Europe, whose markets for commercial property appear fragile, we see the popularity of Dubai, the financial and business hub of the Middle East, continuing to grow. A multitude of international financial service companies have begun to expand into emerging regional hubs such as Dubai. This is exemplified in the popularity of the Dubai International Financial Center (DIFC). High oil prices and the resulting strong economic growth in the GCC have prompted global firms to establish or expand their regional headquarters in Dubai, while the number of regionally focused small and medium enterprises based there has increased. With demand for commercial property outpacing supply over the short term, rents are likely to continue to rise. Project delays all but halted the surge of supply (estimated at 7.3 million square feet by Colliers) that had been expected in 2007, with only a very small tranche (mostly in Jumeirah Lake Towers, DIFC, Sheikh Zayed and TECOM) expected to have been delivered. Most commercial space additions are now expected to hit the market in late 2008 and 2009. We expect office rents to decline in 2009 and, as a result, Dubai commercial property yields to slide back gradually toward the international average. expected impact on construction and real estate stocks
An important question is how these developments might affect the share prices of companies active in the Dubai market. As outlined in the table below, Dubai remains a very important market and therefore a value driver for companies such as Emaar, Union Properties and Arabtec.
Table 6: Business Mix Geared to Dubai Revenues Mix 2007 Focus on Dubai Focus on Other Countries Residential Real Estate Other/ Real Estate Related Arabtec 98% 2% 60% 40% Emaar Properties 79% 21% 90% 10% Union Properties 100% 0% 20% 80%
Source: EFG-Hermes
Most of the actors are more dependent on the residential than the commercial real estate sector (see Table 7). Because we expect that prices for residential property will rise by a further 5% to 10%, we believe Dubai will continue to support earnings next year, even if these do not grow as quickly as in previous years. We believe that prices will begin softening in Dubai starting in 2009, with the impact flowing down to the bottom line during 2009e and 2010e. However, given that both Emaar and Union Properties are undertaking the development of unique and well regarded projects in some of Dubai's prime locations, we feel both of these companies will be largely sheltered from the impact of a price correction.
68 uae research yearbook 2008 2007: year of delays 2008: fundamentally strong uae research yearbook 2008
For Emaar, we see substantial growth for both the top and bottom line in 2008, driven by international operations and the UAE. In Dubai, where for 2008 we see further property price increases in the order of 5 to 10%, the Burj Dubai project is expected to fully kick in and have a positive impact on revenues and profits. Sales over the last six months have exceeded expectations and will be recognized in 2008 figures. The revenue mix of UP will shift to property sales in 2009 and 2010 due to its recognizing revenue upon delivery (since UP follows the completed contract method of revenue recognition), which will strongly enhance EBITDA and margins for both years. In the construction sector, capacity constraints, the significant demand for construction services and the limited number of large qualified contractors have strengthened the negotiating power of contractors such as Arabtec. Therefore, we expect strong margin, revenue and earnings growth in 2008.
Table 7: Trend Matrix for Dubai Trend Macro Sector M&A/IPO Fund Flows Matrix Environment Fundamentals Activity Investor Sentiment
Dubai 2007 + ++ + = Dubai 2008e + + ++ +
Source: EFG-Hermes
Table 7 shows our expectation for different factors that are likely to drive share prices in 2008e. The macro environment for Dubai is expected to remain healthy, with GDP growth remaining high, but with inflation also high. Negative real interest rates are likely to keep the ground fertile for share price appreciation. The sector fundamentals for real estate and construction seem likely to remain solid in 2008e, but less exciting than in 2007e, when property prices appreciated in the high double digits, compared to the 5% to 10% we project for 2008e. We also see the international expansion of bigger regional players such as Emaar starting to support revenues and add to earnings, a factor that should not be underestimated. Another factor expected to boost share prices is potential mergers and acquisitions and IPO activity.
The recent change in the ownership structure and the successful IPO (17x oversubscribed) of Egyptian real estate developer Talaat Mostafa Group and the success of the DP World IPO (19x oversubscribed) bode well for companies going to the market in 2008e. We would not be surprised to see DAMAC, Al Futtaim Group's real estate arm or even Dubai Holding's Limitless making IPOs over the next 12 to 18 months.
We believe that the Dubai real estate sector is set for growth in 2008, albeit at a steadier pace than in recent years. End user demand is expected to continue to be strong as well.We also see other UAE real estate markets increasing in importance, in particular Abu Dhabi. We believe that Dubai will concentrate on project completion, the incorporation of new green building codes and further enhancement of the legal structure. Also, further project delays could continue to stagger supply and postpone our forecast softening of prices to beyond 2008. Further legal improvements with the establishment of the condominium law as well as further deepening of the mortgage will also be positive catalysts for growth.
Sana Kapadia Stefan Schürmann +971 4 363 4007 +971 4 364 19 03 real estate sector 69 [email protected] [email protected] emaar properties
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 13.7 Assets LT Rec. Buy LT Fair Value : AED 20.4 Cash and Time Deposits 2,329 4,474 6,380 9,280 Accounts Receivables 2,089 2,768 3,024 3,824 Development Properties 11,121 19,391 23,693 29,067 Investment Properties & Associates 13,565 14,521 15,990 19,339 Stock Data Net Plant 4,185 7,998 8,691 9,340 Intangibles 2,962 2,962 2,962 2,962 Last Ex-Div Date AED0.2 on 21 Mar 2007 Other Long term assets 5,439 3,312 3,562 3,733 Mkt Value (Local mn) AED83,215 Liabilities and Equity Shares (mn) 6,096 Current Liabilities 7,141 12,61813,503 14,988 Av. Mthly Liquidity (mn) AED6,570 LT Debt 3,992 8,396 9,236 10,159 52-Week High/Low AED14.2/9.75 Other LT Liabilities 12 57 71 74 Bloomberg/Reuters EMAAR UH / EMAAR.DU Minority Interests 566 750 1,001 1,522 Est. Free Float 68% Shareholders' Equity 29,979 33,604 40,492 50,801 Balance Sheet Total 41,690 55,426 64,302 77,544 Income Statement Revenue 14,006 17,948 28,169 39,566 Gross Profit 6,966 7,048 11,708 16,005 (AED) 2006a 2007e 2008e 2009e SG&A (1,282) (1,795) (3,380) (4,748) EPS (Attrib.) 1.04 1.04 1.63 2.34 EBITDA 5,684 5,253 8,328 11,257 EPS growth 22.4% 0.4% 56.4% 43.0% EBIT 5,694 5,339 9,312 13,998 P/E (Attrib.) 13.1 13.1 8.4 5.8 Net Interest Income (Expense) 274 82 (241) (181) Income from Associates 435 1,021 1,2481,250 DPS 0.42 0.45 0.50 0.65 FX Gains (Loss) - --- Dividend Yield 3.0% 3.3% 3.7% 4.7% Extraordinary Items - --- Net Income before Taxes 6,403 6,442 10,319 15,067 BVPS 4.94 5.54 6.67 8.37 Taxes (47) (22) (108) (303) P/BV 2.82.5 2.0 1.6 Net Income after Taxes 6,356 6,419 10,210 14,764 CFPS (Operating Cash Flow) 1.06 1.04 1.51 1.97 Minority Interests (15) (50) (250) (521) P/CF 12.9 13.1 9.0 6.9 Net Attributable Income 6,340 6,369 9,960 14,242 FCF Yield -2.1% 0.2% 4.3% 5.8% Dividends 1,219 2,534 2,743 3,072 Cash Flow Statement EV/EBITDA 20.4 22.7 14.3 10.6 Cash Operating Profit after Tax 6,433 6,333 9,226 12,023 EV/Capacity N/R N/R N/R N/R Cash Flow after Change in WC 9,315 5,762 5,241 6,522 Net Debt (Cash) / Mkt Cap 2.0% 4.7% 3.4% 1.1% Capital Expenditure (11,361) (5,671) (1,437) (1,477) Free Cash Flow (2,046) 91 3,804 5,045 Net Financing 684 2,054 (1,899) (2,145) 15 Change in Cash (1,362) 2,144 1,906 2,900 Ratio 14 Revenue Growth 58.6% 28.1% 57.0% 40.5% Gross Profit Margin 49.7% 39.3% 41.6% 40.5% 13 EBITDA Margin 39.1% 29.3% 29.6% 28.5% Effective Tax Rate 0.3% 0.1% 0.4% 0.8% ROE 21.1% 19.0% 24.6% 28.0% 12 Dividend Payout Ratio 19.2% 43.1% 30.8% 27.6% Net Debt (Cash) / BV -5.5% -11.7% -7.1% -1.7% 11 Net Debt / EBITDA 0.7 1.6 1.1 0.9 EBITDA / Net Interest Expense 5.2 22.1 34.1 32.0 10 Net Debt / EBITDA 0.7 1.6 1.1 0.9 EBITDA / Net Interest Expense 5.2 17.5 25.9 32.8
9 Prices as at 11 December 2007 Source: Emaar, EFG-Hermes estimates 11-Sep-07 11-Jul-07 11-Aug-07 11-Dec-06 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-Jan-07 11-Feb-07 11-Apr-07 11-Jun-07 11-May-07
Stefan Schurmann 70 +971 4 364 1903 uae research yearbook 2008 [email protected] 2007: negative sentiment 2008: time for a revival uae research yearbook 2008
background Emaar, incorporated in Dubai in 1997, has been listed on the DFM since March 2000. It has an authorized share capital of AED6.096 billion, with the Dubai government holding 32% and the public, including a 21% stake held by foreign investors, the rest. With operations in 17 countries, Emaar is the largest publicly listed real estate developer in the Middle East and North Africa. Apart from the UAE, its most important countries of operation by size are Saudi Arabia, India, Egypt, Morocco and Pakistan, with a recent memorandum of understanding with Algeria creating the potential for another large market as well. Besides the core business of residential property development, the group focuses on education, healthcare, hotels, retail (malls) and financial services. Emaar aims to become one of the most valuable companies in the world by 2010.
Since 2001, Emaar has developed roughly 45 million square feet of land and delivered 19,300 residential units. Over the next four years, it plans a total AED154 billion (USD42 billion) of projects, with AED115 billion outside the UAE.The land bank consisted of 504.9 million square meters as of August 2007, including the Dubai joint venture of Bawadi and Libya, but excluding Algeria. The Fair Value of its land bank was AED41.2 billion as of end-2006. Emaar aims to earn 60% to 70% of it revenue from international operations and to generate 12% to 15% of its net profits from recurring income streams by 2010. 2007 - a mixed year
Year-to-date, Emaar's stock price has advanced a modest 8%. We see three main reasons for this. First, the market fundamentally devalued Emaar, lowering its expectations for future gross margins after Emaar stopped land sales solely to boost revenue and profits. Second, the company's reputation was tarnished by communications problems. A share swap was announced with Dubai Holding but did not happen. Only later in the year did it result in Emaar announcing a 50% joint venture with Tatweer, called Bawadi, in Dubai.
Also, a potential lawsuit at the Saudi subsidiary added to uncertainty.Third, Emaar's exposure to the deteriorating US real estate market, with its US-based John Laing Homes subsidiary accounting for roughly 15% of its revenue, also contributed to the relative underperformance.
On the positive side, corporate communication and transparency, such as with financial targets and information on projects, improved. Results for 9M2007 showed that revenue rose 48% and that net profits inched up to AED0.79 per share from AED0.76.The gross margin for the nine months retreated to 41% from 50% in 2006 and 57% in 2005. For the full-year 2007e, we expect total revenue of AED17.9 billion and net profits of AED6.4 billion. 2008 - profits growth drives revival
For 2008, we see substantial growth for the top and bottom line. International operations are expected to start to contribute to revenues and also profits, driven especially by India, Saudi Arabia, Egypt and Morocco. A planned IPO for Emaar-MGF (India) should take place in January, adding a third big market, after the UAE and Saudi Arabia, to Emaar's portfolio. In Dubai, where we see property prices increasing a further 5% to 10%, the Burj Dubai project is expected to fully kick in and bolster revenue and profits for 2008e. We estimate that revenue will increase 57% to AED28.2 billion in 2008e and net profits 56% to AED10.0 billion, which should be a positive driver for the share price. recommendation We continue to see Emaar as undervalued based on our increased sum-of-the-parts value of AED20.4 per share, offering 51% upside. The fair value can be subdivided into AED10.5 per share for the UAE and AED9.4 per share for the international operation, with the bulk of the international value accounted for by India (AED3.4) and Saudi Arabia (AED2.5). By type of real estate (ex-Associates); residential accounts for AED7.1 per share, commercial for AED2.0, retail for AED3.8 and hospitality for AED1.7. Associates Emaar-MGF (India) and EEC (Saudi Arabia) account for AED3.4 and AED1.9 per share, respectively. Emaar-MGF is included in our valuation at 20% below the expected IPO price. Our estimated fair value for EEC, which is based on a DCF, is 105% above the current market value. As our DCF only takes into account the residential portion of the development, we believe EEC holds significantly further upside than we currently factor in.
The company trades at 8.3x our 2008e EPS and 2.3x 2007e book value (decreasing to around 1.1x when valuing the land bank at market prices). Further upside to our valuation is possible once the Algerian and or Libyan master plan details are announced, the IPO of Emaar- MGF occurs and the EEC is further developed. We have a ST/LT Buy recommendation.
real estate sector | emaar properties 71 union properties
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 5.02 LT Rec. Buy LT Fair Value : AED 5.75 Assets Cash and Time Deposits 52 421 2,404 5,134 Accounts Receivables 1,779 2,156 2,371 2,442 Inventory 576 747 820 845 Stock Data Other Current Assets 61 479 1,069 1,361 Last Ex-Div Date N/A Net plant 367 365 362 359 Mkt Value (Local mn) AED13,968 Development & Invest. Properties 4,404 6,545 10,915 8,664 Shares (mn) 2,783 Other Long Term Assets 312 439 466 480 Av. Mthly Liquidity (mn) AED721 Liabilities and Equity 52-Week High/Low AED5.02 / 2.32 ST Debt 776 1,200 1,400 1,600 Bloomberg/Reuters UPP UH / UPRO.DU Payables & Suppliers 1,471 1,5481,699 1,750 Est. Free Float 52% Other Current Liabilities 3 1,081 5,304 4,392 Provisions 3836 35 33 LT Debt 607 2,000 4,000 3,000 (AED) 2006a 2007e 2008e 2009e Other Liabilities 103 80 80 80 EPS (Attrib.) 0.22 0.23 0.25 1.66 Net Worth 4,553 5,207 5,889 8,430 EPS (Attrib.) Growth 6.2% 6.5% 4.3% 578.5% P/E (Attrib.) 22.821.4 20.5 3.0 Balance Sheet Total 7,551 11,152 18,407 19,286 Income Statement DPS 0.00 0.00 0.00 0.75 Dividend Yield 0.0% 0.0% 0.0% 14.9% Revenue 2,525 2,781 2,715 11,719 Gross Profit 416.8 590.7 402.3 4,748 BVPS 1.64 1.87 2.12 3.03 SG&A (73.3) (126.5) (135.8) (263.7) P/BV 3.1 2.7 2.4 1.7 EBITDA 370.5 496.3 299.2 4,517 CFPS (Operating CF) (0.16) 0.31 1.51 1.23 EBIT 343.5 464.2 266.5 4,484 P/CF (31.2) 16.0 3.3 4.1 FCF Yield -12.7% -10.0% -1.5% 40.3% Net Interest Income (Expense) (7.8) (73.3) (83.4) (66.9) Other Income (Expense) 278.3 263.0 498.9 210.5 EV / EBITDA 41.3 33.7 56.7 3.0 EV / Capacity N/R N/R N/R N/R Net Income before Taxes 614.0 653.9 682.1 4,628 Net Debt (Cash) / Mkt Cap 9.5% 19.9% 21.5% -3.8% Taxes - - - - Net Income after Taxes 614.0 653.9 682.1 4,628 Minority Interest - - - - Net Attributable Income 614.0 653.9 682.1 4,628 Dividends ---2,087 Cash Flow Statement 5.0 Cash Op. Profit after Tax 647.5 684.4 713.3 4,659 4.5 Cash Flow after change in WC (447.8) 873.2 4,210 3,410 Capex & Add. to Dev. & Inv. Properties (1,321) (2,267) (4,420) 2,215 4.0 Free Cash Flow (1,769) (1,394) (210.5) 5,625 3.5 Non-Op. Cash Flow (78.8) (53.6) (7.1) (7.6) Cash Flow before Financing (1,848) (1,448) (217.6) 5,617 3.0 Net Financing 606.0 1,817 2,200 (2,887) 2.5 Change in Cash (1,242) 369.1 1,982 2,731 Ratios 2.0 Revenue Growth 81.9% 10.1% -2.4% 331.6% Gross Profit Margin 16.5% 21.2% 14.8% 40.5% EBITDA Margin 14.7% 17.8% 11.0% 38.5% 11-May-07 11-Jul-07 11-Apr-07 11-Jun-07 11-Sep-07 11-Jan-07 11-Aug-07 11-Feb-07 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-Dec-06 Effective Tax Rate 0.0% 0.0% 0.0% 0.0% ROAE 13.5% 13.4% 12.3% 64.6% Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% Net Debt (Cash) 1,331 2,779 2,996 (534) Net Debt (Cash) / BV 29.2% 53.4% 50.9% -6.3% Net Debt / EBITDA 3.6 5.6 10.0 (0.1) Prices as at 11 December 2007 Source: UP, EFG-Hermes estimates
Sana Kapadia 72 +971 4 363 4007 uae research yearbook 2008 [email protected] 2007: focus on project development 2008: motoring ahead uae research yearbook 2008
background Union Properties (UP), established in 1987 by Emirates Bank Group, has become one of Dubai's leading real estate developers. Its activities include: i) the management and maintenance of rental properties ranging from residential, retail and office space to cold stores and warehouses, ii) property development, iii) contracting, and iv) other property-related services, which include project and facilities management, district cooling and interior design.The company currently owns two serviced apartment facilities and a hotel, with plans to expand its lodging portfolio with three new hotels. UP is also investing heavily into motorsport-related activities, building and franchising Formula One theme parks and related ventures, including Speedcar racing and the Dubai Autodrome. 2007 - focus on execution, strong sales activity
During 2007, UP focused on property development and launched a number of freehold projects for sale. All villas and bungalows offered in its Green Community MotorCity development have been sold, as have 80% of the units released in two phases of Uptown MotorCity. Sales in its DIFC developments, begun in 2006, picked up considerably in 2007. UP took both of its DIFC developments, Limestone House and Index, off the market for about a month, and re-released them at higher prices, with robust sales. We believe DIFC property sales are increasing due to: i) buyers being able to view tangible construction progress, ii) an increasing perception that the DIFC will be a livable, easily accessible and quality development, and iii) UP's prices are lower than market prices of other developments available for sale within the DIFC. Elsewhere, UP's rental portfolio continues to generate cash flow, while its contracting business Thermo is close to completing its Terminal 3 airport contract, which has helped to accelerate revenue recognition in 2007. UP's 9M2007 revenue rose 14.1% Y-o-Y to AED2,024 million and net income 52.3% to AED471.7 million, both ahead of our expectations. Revenue for 9M2007 reflected the recognition of high-margin plots sales within MotorCity. We have upgraded our 2007 forecasts to reflect strong second and third quarter revenue growth, faster-than-expected resort to debt, a better-than-expected contribution from other income and an expected gain on revaluation of investment properties in 4Q2007. We now look for FY2007e revenue of AED2,781 million, EBITDA of AED496.3 million and net income of AED653.9 million. 2008 - positive spiral for prices, project development at forefront
We have revised our forecasts for 2008 and beyond based on: i) a buoyant real estate market, ii) strong underlying demand, iii) our expectation that prime commercial and retail space in Index and Limestone will sell at lucrative prices, and iv) more optimistic expectations for UP's other business segments. Because UP applies the completed contract method, the recognition of revenue from property sales is recorded only upon delivery, i.e. 2009 and 2010. This suggests that the impact of our upwardly revised selling price assumptions will not be seen in 2008. We also forecast that administrative and interest costs will ramp up to reflect more intense marketing and increased debt financing. For 2008, we include the contribution from investment income that reflects the recognition of sales upon the handover of Green Community West. We expect UP to announce new projects in 1H2008 that would result in deliveries from 2011 onwards and tack on nicely with UP's existing pipeline, which we estimate will run out in 2010. Moreover, UP will launch its Speedcar business in 2008, although we do not expect to see earnings contribution in 2008. The company will also ramp up construction of its Formula One theme park, expected to begin operating by 2009. These motorsports-related ventures mark a strategic diversification away from traditional property development. We also anticipate that UP's contracting business Thermo will win new contracts, perhaps including the AED5 billion Dubai airport and AED7 billion Jebel Ali airport projects. recommendation We maintain our ST/LT recommendation at Buy. With its strong market position and brand, UP gives investors exposure to the dynamic Dubai real estate sector. We believe that in the short term its successful freehold residential sales will allow it to raise selling prices, an increase we have factored into our revised forecasts. Among the elements that will create long-term value for investors and stand it in good stead in softer markets, we believe, are: i) the proven strength of its business model, ii) its commitment to delivering value and quality, iii) its strong brand recognition, and iv) the potential success of its diversification into motorsports.We believe the company will announce new projects in 2008 that will be positive for both our forecasts and estimated Fair Value. Our new Long-Term Fair Value of AED5.75 per share offers 15% upside to the current price of AED5.02 per share.
real estate sector | union properties 73 arabtec
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 9.40 LT Rec. Buy LT Fair Value : AED 10.6 Assets Cash and Time Deposits 129 1,125 787 829 Accounts Receivables 1,223 1,550 3,347 3,454 Inventory 215 249 462 503
Stock Data Other Current Assets 45 92 134 148 Last Ex-Div Date AED0.15 on 17 April 2007 Net plant 416 612 9981,150 Mkt Value (Local mn) AED5,621 Intangibles 179 156 465 663 Shares (mn) 598 Other Long Term Assets 129 181 264 291 Av. Mthly Liquidity (mn) AED599 Liabilities and Equity 52-Week High/Low AED9.43/ 4.37 ST Debt 157 119 79 2 Bloomberg/Reuters ATRC UH / ARTC.DU Payables & Suppliers 1,226 2,395 4,252 4,222 Est. Free Float 55% Other Current Liabilities 896 136 149 Provisions 4867 71 73 LT Debt 1 86 4 (AED) 2006a 2007e 2008e 2009e Other Liabilities 85 96 136 149 Minority Interest 26 78279 82 EPS (Attrib.) 0.36 0.83 1.58 2.02 EPS (Attrib.) Growth 30.8% 129.1% 89.9% 27.8% Net Worth 784 1,107 1,498 2,357 P/E (Attrib.) 25.9 11.3 6.0 4.7 Balance Sheet Total 2,335 3,965 6,457 7,037 Income Statement DPS 0.15 0.29 0.63 0.81 Dividend Yield 1.6% 3.1% 6.7% 8.6% Revenue 2,810 4,133 8,126 8,984 Gross Profit 357.0 684.2 1,450 1,720 BVPS 1.51 1.85 2.50 3.94 SG&A (175.9) (273.2) (467.3) (505.3) P/BV 6.2 5.1 3.82.4 EBITDA 311.9 639.8 1,276 1,512 CFPS (Operating CF) 0.30 2.82 1.62 2.23 EBIT 207.3 518.9 1,110 1,321 P/CF 31.3 3.3 5.84.2 Net Interest Income (Expense) 3.7 3.2 18.4 4.9 FCF Yield 3.5% 3.0% -2.4% 9.4% Other Income (Expense) 5.9 (25.1) (158.5) (71.1) Net Income before Taxes 216.9 496.9 969.7 1,255 EV / EBITDA 18.1 7.2 3.9 3.2 EV / Capacity N/R N/R N/R N/R Taxes - - - - Net Debt (Cash) / Mkt Cap 0.5% -17.8% -12.5% -14.6% Net Income after Taxes 216.9 496.9 969.7 1,255 Minority Interest - - - - Net Attributable Income 216.9 496.9 969.7 1,255 Dividends 78.0 173.9 377.4 482.5 10 Cash Flow Statement
9 Cash Op. Profit after Tax 327.1 637.3 1,139 1,448 Cash Flow after change in WC (54.2) 1,530 827.8 1,270 8 Capital Expenditure (169.7) (295.0) (960.0) (740.0) 7 Free Cash Flow 195.5 169.8 (132.2) 530.1 6 Non-Op. Cash Flow 48.9 (41.1) (42.3) (14.6) 5 Cash Flow before Financing (175.0) 1,194 (174.5) 515.5
4 Net Financing 182.0 (152.9) (385.0) (473.5) Change in Cash 7.0 1,041 (559.5) 42.0 3 Ratios 2 Revenue Growth 9.5% 47.1% 96.6% 10.6% Gross Profit Margin 12.7% 16.6% 17.8% 19.1% EBITDA Margin 11.1% 15.5% 15.7% 16.8% 11-Dec-07 11-May-07 11-Dec-06 11-Jan-07 11-Feb-07 11-Mar-07 11-Apr-07 11-Jun-07 11-Jul-07 11-Aug-07 11-Sep-07 11-Oct-07 11-Nov-07 Effective Tax Rate 0.0% 0.0% 0.0% 0.0% ROAE 8.0% 52.6% 74.5% 65.1% Dividend Payout Ratio 36.0% 35.0% 38.9% 38.4% Net Debt (Cash) 28.6 (998.4) (702.3) (823.1) Net Debt (Cash) / BV 3.6% -90.2% -46.9% -34.9% Net Debt / EBITDA 0.1 (1.6) (0.6) (0.5) Prices as at 11 December 2007 Source: Arabtec, EFG-Hermes estimates
Sana Kapadia 74 +971 4 363 4007 uae research yearbook 2008 [email protected] 2007: phenomenal growth 2008: expectations and performance to surge uae research yearbook 2008
background Arab Technical Construction Company (Arabtec) is one of the UAE's largest local contractors and the only one that is listed. Its backlog is estimated at around AED13.0 billion, with most of the work concentrated in Dubai and on residential and commercial projects. Recently, however, it has also taken on more infrastructure and civil works contracts. During 2007, Arabtec won its first contract in Abu Dhabi, in addition to an AED4.6 billion project to refurbish and upgrade the Nad Al Sheba racecourse in Dubai. In November, Arabtec acquired a 60% stake in another leading local contractor, Target Construction, which specializes in civil, electromechanical, marine and oil and gas projects. 2007 - strong financials, sound strategy
Arabtec has had a phenomenal year, with strong results, contract wins and strategic acquisitions.We have estimated a price of AED1,050 million (both EV and equity value as we assume zero net debt) for a 100% stake in Target, on the assumption that Arabtec will have bought the remainder of the company by end-2008. To arrive at this price, we applied a 20% discount to Arabtec's enterprise value/revenue multiple based on 2007e revenues for both Target and Arabtec. The acquisition of Target, apart from adding to Arabtec's capacity and broadening its product offering, also helps extend its geographical reach. Arabtec has been working to diversify outside of Dubai, notably with its first contract in Abu Dhabi, an emirate which we believe is still at an early phase of its property boom. Arabtec's 9M2007 revenue jumped 39.4% Y-o-Y to AED2,062 million, driven by better-than-expected top-line growth in the second and third quarters, when project deliveries helped to accelerate revenue recognition. As a result, working capital declined significantly, boosting operating cash flow. Profit margins continued to broaden in 2007, with the gross margin widening to 19.3% in 3Q2007 from 16.9% in 2Q2007 and 12.9% in 1Q2007. Top-line growth, cost efficiencies and unprecedented improvements in margins boosted 3Q2007 net income 271.6% Y-o-Y and 49.9% Q-o-Q to AED169.9 million. We also expect a strong fourth quarter and look for full year revenue of AED4,132 million, gross and EBITDA margins of 16.6% and 15.5% and a net income of AED496 million. 2008 - strong revenue and margin growth underscore expectations
Our outlook for 2008 is bullish. We expect solid financial results based on: i) revenue that is recognized from projects as they get delivered, ii) from Target 's contribution, and iii) as our expectations of greater pricing power continues to bolster margins. We estimate 2008e revenue of AED8,126 million, gross and EBITDA margins of 17.8% and 15.7% and net income of AED943.5 million. Our forecasts consolidate Arabtec's 60% stake in Target for 2008 and a 100% stake from 2009. Our forecasts for Target are based on 2006 revenue and, going forward, we have assumed that its revenue, backlog and income growth are in line with Arabtec's. This implies an element of uncertainty to our 2008 forecasts and beyond.
Arabtec's labor force has been stretched, and we believe its acquisition of Target will give it the capacity to undertake new projects. We expect new contract wins and anticipate that both its Pakistan and Qatar operations will become operational in 2008. Arabtec has gained experience from its work on prestigious projects such as Burj Dubai, and we believe it will bid for, and is a strong contender to win, similar projects such as Nakheel's AED1.8 billion, 1,050-meter-tall Al Burj Tower and Kuwait's 1,100-meter City of Silk Tower. We are conservative in our forecasts beyond 2010 in our belief that construction is near the peak of its cycle and will cool down after 2009. recommendation We reiterate our ST Buy recommendation on Arabtec, based on its strong earnings growth and attractive near-term multiples. With our estimated Fair Value offering around 13% upside potential, we also re-iterate our LT Buy recommendation. Positive surprises could lead us to raise our long-term forecast and valuations. These might include: i) more contracts in Abu Dhabi and outside the UAE, and ii) an extension of the Dubai market's boom beyond our assumptions. We believe there is a strong possibility the stock price will overshoot our estimated LTFV in 2008, especially if our 2008e earnings are achieved.The main risks to our forecasts and valuation are: i) Arabtec's overexposure to residential and commercial projects, ii) delays or defaults on payments from clients should real estate conditions deteriorate, iii) increasing competition from new contractors, iv) its inability to sustain its current economies of scale, v) a delay in the integration of international ventures or in the execution of regional contracts due to capacity constraints or other impediments, and vi) a liquidity crunch or geopolitical unrest that might dampen confidence in the real estate sector.
construction sector | arabtec 75 dana gas
ST Rec. Reduce Current Price: AED 2.13 December Year End (AED mn) 2006a 2007e 2008e 2009e LT Rec. Sell LT Fair Value : AED 1.46 Assets Cash and Time Deposits 2,839 1,797 1,536 1,137 Accounts Receivables 2 348204 228 Inventory - 169 227 257 Other Current Assets - 53 231 259 Stock Data Net plant 862 2,400 3,007 3,723 Last Ex-Div Date N/A Intangibles 3,140 5,900 5,855 5,810 Mkt Value (Local mn) 12,780 Other Long Term Assets - 231 243 255 Shares (mn) 6,000 Av. Mthly Liquidity (mn) AED813.6 Liabilities and Equity 52-Week High/Low AED2.33 / 1.30 ST Debt 4 12 13 15 Bloomberg/Reuters DANA UH/DANA.AD Payables & Suppliers 25 284 378 385 Est. Free Float 35% Other Current Liabilities - - - - LT Debt - 3,692 3,694 3,697 Minority Interest - - - - (AED) 2006a 2007e 2008e 2009e Net Worth 6,814 6,909 7,216 7,572 EPS (Attrib.) 0.080.09 0.12 0.16 Balance Sheet Total 6,843 10,897 11,302 11,668 EPS (Attrib.) Growth -65.8% -59.7% 223.7% 16.0% Income Statement P/E (Attrib.) 54.3 134.841.6 35.9 Revenues 57.3 540.0 2,480 2,776
DPS ----Gross Profit 20.1 475.2 1,099 1,215 Dividend Yield 0.0% 0.0% 0.0% 0.0% SG&A (5.0) (87.9) (177.3) (194.3) EBITDA 15.1 387.3 921.7 1,021 BVPS 1.14 1.15 1.20 1.26 EBIT (16.4) 161.3 637.4 708.8 P/BV 1.88 1.85 1.77 1.69 Net Interest Income (Expense) 151.8 (45.0) (208.6) (221.8) Other Income (Expense) - - 118.0 123.9 CFPS (Operating CF) 0.04 0.05 0.10 0.11 Extraordinary Items 100.0 154.0 - - P/CF 47.9 39.821.6 19.1 Net Income before Taxes 235.4 270.3 546.8 610.9 FCF Yield -1.6% -6.0% 2.2% 1.8% Taxes - (175.5) (239.8) (254.7) EV/EBITDA 660.3 37.816.2 15.0 Net Income after Taxes 235.4 94.8 307.0 356.2 EV/Capacity N/A N/A N/A N/A Minority Interest - - - - Net Debt (Cash) / Mkt Cap -22.2% 14.7% 16.7% 19.8% Net Attributable Income 235.4 94.8 307.0 356.2 Dividends - - - - Cash Flow Statement Cash Op. Profit after Tax 15.1 211.8681.9 766.2 2.5 Cash Flow after Change in WC (4.9) (87.8) 702.2 694.5 Capital Expenditure (250.0) (712.6) (226.9) (252.5) Free Cash Flow (254.9) (800.4) 475.3 442.0 2.0 Non-Op. Cash Flow 1.0 (37.0) (274.1) (273.9) Cash Flow before Financing (253.9) (837.4) 201.3 168.1 Net Financing (2,051) 3,670 0 0
1.5 Change in Cash (2,305) 2,833 201.3 168.1 Ratios Revenue Growth N/A 842.4% 359.3% 11.9% Gross Profit Margin 35.0% 88.0% 44.3% 43.8% 1.0 EBITDA Margin 26.3% 71.7% 37.2% 36.8% Effective Tax Rate 0.0% 64.9% 43.8% 41.7% ROAE 3.5% 1.4% 4.3% 4.8% 11-Jul-07 11-Jan-07 11-Apr-07 11-Jun-07 11-Sep-07 11-Feb-07 11-Aug-07 11-Dec-06 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-May-07 ROAIC -0.2% 3.9% 0.0% -0.2% Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% Net Debt (Cash) (2,839) 1,873 2,134 2,533 Net Debt (Cash) / BV -41.7% 27.1% 29.6% 33.4% Net Debt (Cash) / EBITDA (188.6) 4.8 2.3 2.5 EBITDA / Net Interest Expense 0.1 (8.6) (4.4) (4.6) Prices as at 11 December 2007 Source: Dana Gas, EFG-Hermes estimates
76 Abid Riaz Mohammad Madani uae research yearbook 2008 +971 4 363 4005 +971 4 363 4003 [email protected] [email protected] 2007: gas delays 2008: year of delivery uae research yearbook 2008
background Dana Gas, a natural gas company operating in the UAE and in the Middle East and North Africa, owns, processes and distributes natural gas through two wholly owned subsidiaries and through an affiliate controlled by Sharjah-based Crescent Petroleum. The company raised AED2.0 billion in an initial public offering in late 2005. Dana has a contract for the supply of natural gas from Iran, as well as agreements to distribute gas to industrial clients and government-owned utilities in the UAE.
Dana Gas entered a series of strategic alliances in 2006; the first was a joint venture to build, own and operate an LPG plant in Egypt, the second the development of an LNG terminal in Pakistan and the third a venture with Saudi partners in Saudi Arabia.The company also acquired Centurion Energy in January 2007, a Canada-based oil and gas E&P company, with assets in the Middle East and North Africa. More recently, Dana Gas signed a strategic alliance with the Kurdistan Regional Government of Iraq to develop, process and transport natural gas. 2007 - contribution from centurion, but still no iranian gas
The continuing delay in the company's key Iranian gas deal has meant that Dana Gas's 3Q2007 results were significantly below our expectations. Revenues were flat Q-o-Q and reflected contribution solely from the company's Centurion business, while net profits declined 24.1% Q-o-Q. Given these results, and the fact the company's cornerstone Iranian gas deal, which we had forecast to contribute to earnings in 2H2007, failed to materialize this year, we downgraded our revenue and net income forecasts by 67% and 70% for 2007.
Dana Gas meanwhile signed a strategic alliance with the Kurdistan Regional Government of Iraq in 1H2007 to develop, process, and transport natural gas from the Khor Mor Gas field and to provide gas to fuel domestic electric power generation plants currently under construction.
The company also issued a USD1 billion sukuk to help finance its future projects/acquisitions. The convertible, Islamically compliant bond matures in 2012 and has a fixed coupon payment of 7.5%. With the strike price to be set nine months after the issuance date,we believe the terms of this bond to be particularly favorable to bond holders and, with the greater likelihood of bond holders converting to equity, could be materially dilutive to existing shareholders. 2008 - iranian gas to flow
While we still believe the Iranian gas deal will happen (given the capital already committed by both parties), we now anticipate the start of this contract at the beginning of 2008. Moreover, we had previously expected that Dana Gas would acquire Pakistan's Sui Southern Gas Company as part of the Pakistan government's privatization plan and that this would start to contribute to our estimates from 2008. This deal now looks highly unlikely after the government decided to put its privatization process on hold at least until the new government takes over. Therefore, we have reduced our 2008 revenue and profit estimates by 53% and 43%.
The Khor Mor project in the Kurdish region of Iraq is now 60% complete and production is scheduled for early 2008. However, given the lack of details that Dana Gas has provided, i.e. potential production levels and therefore subsequent revenue and profit expectations, we have chosen not to include the project in our forecasts at this stage. With the recent political instability in the Kurdish region, we believe there is a risk of possible delays. recommendation After the delay in the Iranian contract this year and the exclusion of Pakistan's Sui Gas company from our estimates, our new Long- Term Fair Value is substantially below the current share price and, given the major risk Dana Gas faces with respect to further delays to its Iranian contract, we assign a LT Sell recommendation on the company.
Moreover, on a valuation basis, the company does not appear cheap, particularly given the lack of visibility regarding delivery of the Iranian gas and the uncertainty therefore over our future forecasts. For the short term, we are nevertheless mindful of the positive sentiment that would follow the announcement of the long-awaited Iranian gas deal, and thus our ST recommendation is Reduce.
energy | dana gas 77 tabreed
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Accumulate Current Price: AED 3.35 LT Rec. Buy LT Fair Value : AED 4.19 Assets Cash and Time Deposits 867 344 195 510 Accounts Receivables 880 319 348 451 Inventory 27 3839 48 Other Current Assets 108255 277 355 Stock Data Net plant 2,038 2,977 4,885 6,231 Last Ex-Div Date AED0.08 on 07 May 2007 Intangibles 3830 30 30 Mkt Value (Local mn) AED3,799 Other Long Term Assets 111 150 172 197 Shares (mn) 1,134 Liabilities and Equity Av. Mthly Liquidity (mn) AED504.7 ST Debt 443 308308 308 52-Week High/Low AED3.48 / 1.67 Payables & Suppliers 241 281 305 441 Bloomberg/Reuters TABREED UH/TABR.DU Other Current Liabilities 191 281 315 448 Est. Free Float 76% Provisions 8888 LT Debt 1,788 1,866 2,566 3,066 (AED) 2006a 2007e 2008e 2009e Long Term Payables 88 2 0 0 EPS (Attrib.) 0.10 0.06 0.080.09 Minority Interest 122 137 154 178 EPS (Attrib.) Growth 84.1% -40.3% 39.9% 12.3% Net Worth 1,188 1,230 2,290 3,375 P/E (Attrib.) 33.7 56.4 40.3 35.9 Balance Sheet Total 4,069 4,114 5,947 7,824 Income Statement DPS 0.04 0.02 0.03 0.03 Revenues 470.0 597.3 726.3 1,062 Dividend Yield 1.3% 0.7% 0.9% 1.0% Gross Profit 248.4 316.6 421.3 621.5 SG&A (84.8) (137.4) (152.5) (223.1) BVPS 1.13 1.082.02 2.33 P/BV 2.96 3.09 1.66 1.44 EBITDA 163.7 179.2 268.7 398.4 EBIT 104.3 123.3 176.3 248.3 CFPS (Operating CF) 0.16 0.16 0.24 0.27 Net Interest Income (Expense) (40.3) (51.5) (89.7) (98.4) P/CF 21.5 21.2 14.1 12.2 Other Income (Expense) 61.3 25.6 42.0 33.1 FCF Yield -25.5% -22.8% -48.7% -31.3% Net Income before Taxes 125.3 97.4 128.7 183.0 Taxes - - - - EV/EBITDA 31.3 32.2 24.7 19.8 Net Income after Taxes 125.3 97.4 128.7 183.0 EV/Capacity 34.1 30.3 22.9 14.4 Minority Interest (20.9) (30.1) (34.5) (47.8) Net Debt (Cash) / Mkt Cap 42.1% 52.0% 76.2% 81.4% Net Attributable Income 104.4 67.3 94.2 135.2 Dividends - 24.9 34.850.0 Cash Flow Statement Cash Op. Profit after Tax 163.7 179.2 268.7 398.4 3.5 Cash Flow after change in WC 66.4 718.2 239.1 409.2 3.3 Capital Expenditure (995.3) (1,534) (2,000) (1,500) 3.1 Free Cash Flow (929.0) (815.8) (1,761) (1,091) 2.9 Non-Op. Cash Flow (103.9) (304.3) (89.4) (76.4) 2.7 Cash Flow before Financing (1,033) (1,120) (1,850) (1,167) 2.5 2.3 Net Financing 1,109 71.3 1,652 1,442 2.1 Change in Cash 75.9 (1,049) (197.8) 274.4 1.9 Ratios Revenue Growth 17.2% 27.1% 21.6% 46.3% 1.7 Gross Profit Margin 52.9% 53.0% 58.0% 58.5% 1.5 EBITDA margin 34.8% 30.0% 37.0% 37.5% Effective Tax Rate 0.0% 0.0% 0.0% 0.0% ROAE 9.2% 5.6% 5.4% 4.8% 11-Jun-07 11-Aug-07 11-Feb-07 11-Jul-07 11-Sep-07 11-Jan-07 11-Apr-07 11-Oct-07 11-Nov-07 11-Dec-07 11-Dec-06 11-Mar-07 11-May-07 ROAIC 3.6% 3.5% 4.0% 4.1% Dividend Payout Ratio 0.0% 37.0% 37.0% 37.0% Net Debt (Cash) 1,480 1,830 2,679 2,864 Net Debt (Cash)/BV 124.6% 148.7% 117.0% 84.9% Net Debt / EBITDA 9.0 10.2 10.0 7.2 EBITDA/Net Interest Expense (4.1) (3.5) (3.0) (4.0) Prices as at 11 December 2007 Source: Tabreed, EFG-Hermes estimates
Abid Riaz Mohammad Madani uae research yearbook 2008 78 +971 4 363 4005 +971 4 363 4003 [email protected] [email protected] 2007: steady progress 2008: spending on growth uae research yearbook 2008
background Tabreed is the pioneer and leading provider of district cooling services in the UAE and the Middle East - and the largest provider on a commercial scale worldwide. District cooling systems dispense chilled water from central cooling plants to customers at multiple sites. Growth in demand is underpinned by economic growth in the UAE and regionally, and more specifically by the strength of GCC real estate development. District cooling is a cheaper and cleaner alternative to air cooling and has a penetration rate of between 70% and 80% of all new developments. The company operates around 25 plants in the UAE and has established joint ventures in Qatar, Bahrain, Saudi Arabia, Oman, Jordan and more recently, with Aldar Properties, in Abu Dhabi. 2007 - major contract wins
Tabreed continued to make solid progress in 2007, with the company's Services and Manufacturing divisions in particular exhibiting strong growth Y-o-Y for the first nine months of the year. The company signed a number of major agreements, not least the formulization of a joint venture with Aldar Properties to build 25 new plants, providing 1.5 million refrigeration tons (RT) over the next five years for the developer's projects in Abu Dhabi.
Despite the company's continuing expansion, we remain mindful of the fact that with Tabreed currently in its growth phase, the cost of additional capacity tends to hit the bottom line without a simultaneous contribution to revenues. Indeed, Tabreed reported 3Q2007 results below our expectations. While revenues for the quarter rose 49.7% Y-o-Y, operating costs that were higher than anticipated held back profits and meant that net profit for the quarter came in below our expectations. As capacity is added, however, top line growth will also ramp up gradually, and our forecasts further out reflect this. 2008 - build-out phase continues
We expect 2008 to be largely a continuation of 2007. We forecast installed capacity to continue to rise substantially, driven by further plant openings. While revenues are forecast to increase by 22% to AED726 million, contribution to the top line from the company's Contracts business will be significantly lower as contracts near their term end. Although financing costs are expected to continue to climb, a stronger contribution from the company's joint ventures in 2008 should lead to a 40% increase in profits to AED97.2 million, we believe. We also expect 2008 to be another big year in terms of capital expenditure, with Tabreed likely to spend a further AED2.0 billion. recommendation We remain strong believers in Tabreed's business model and its growth drivers and see immense potential for the rollout of the technology across the GCC.
While our LT Fair Value offers considerable upside to the current share price, we are mindful of the company's short-term valuation multiples, which are high. However, we would argue that Tabreed deserves a premium given its dominant market share, relatively low-risk growth potential and anticipated strong earnings progression over our forecast period. Furthermore, we expect positive news flow to continue and believe the company will secure more contracts, which could drive forecast upgrades. Our recommendation therefore is ST Accumulate / LT Buy.
utilities | tabreed 79 aabar energy
ST Rec. Neutral Current Price: AED 3.88 December Year End (AED mn) 2006a 2007e 2008e 2009e Assets LT Rec. Accumulate LT Fair Value : AED 3.75 Cash and Time Deposits 779 1,585 1,902 2,093 Accounts Receivables 348317 313 355 Inventory 97 62 64 72 Other Current Assets - - - - Stock Data Net plant 2,100 1,386 1,182 976 Last Ex-Div Date AED0.05 on 13 May 2007 Intangibles 1,523 1,643 1,653 1,663 Mkt Value (Local mn) AED3,492 Other Long Term Assets 121 114 114 114 Shares (mn) 900 Liabilities and Equity Av. Mthly Liquidity (mn) AED613.9 ST Debt 138(53) (44) (248) 52-Week High/Low AED4.61 / 1.54 Payables & Suppliers 252 288 254 274 Bloomberg/Reuters AABAR UH / AABAR.AD Other Current Liabilities 88 154 162 170 Est. Free Float 77% Provisions - - - - LT Debt 2,139 1,630 1,630 1,630 Long Term Payables 594 605 664 728 (AED) 2006a 2007e 2008e 2009e Minority Interest 110 143 157 173 Net Worth 1,648 2,340 2,405 2,545 EPS (Attrib.) 0.11 0.82 0.12 0.21 Balance Sheet Total 4,968 5,108 5,228 5,273 EPS (Attrib.) Growth -84.3% 673.8% -85.1% 69.1% P/E (Attrib.) 36.4 4.7 31.6 18.7 Income Statement Revenues 918.4 1,363 1,268 1,439 DPS 0.05 0.19 0.19 0.19 Gross Profit 535.6 1,063 959 1,089 Dividend Yield 1.3% 4.9% 4.9% 4.9% SG&A (96.6) (109.1) (101.5) (115.2) Exploration Expenses (50.5) (156.8) (145.8) (165.5) BVPS 1.83 2.60 2.67 2.83 EBITDA 396.2 814.0 727.3 825.5 P/BV 2.10 1.481.44 1.36 EBIT 235.5 535.8 449.2 547.4 Net Interest Income (Expense) (68.7) (85.9) (24.9) (12.2) CFPS (Operating CF) 0.44 1.13 0.43 0.52 Other Income (Expense) 67.7 - - - P/CF 8.77 3.41 8.93 7.47 Net Income before Taxes 234.4 449.9 424.3 535.2 FCF Yield -15.3% -6.5% 0.5% -1.5% Taxes (87.2) (214.3) (179.7) (219.0) Net Income after Taxes 147.2 235.6 244.7 316.2 EV/EBITDA 12.20 4.34 4.42 3.66 Minority Interest (52.0) (136.0) (134.9) (130.6) Net Debt (Cash) / Mkt Cap 39.4% 1.9% -7.3% -12.8% Net Attributable Income 95.2 736.6 109.8 185.6 Dividends 45.0 45.0 45.0 45.0 Cash Flow Statement Cash Op. Profit after Tax 447.3 463.6 412.8476.0 5.0 Cash Flow after change in WC 371.5 565.5 382.0 445.1 4.5 Capital Expenditure (695.6) (653.6) (417.2) (556.3) 4.0 Free Cash Flow (324.1) (88.1) (35.2) (111.2) 3.5 Non-Op. Cash Flow (1,888) 334.9 (27.2) (14.0) 3.0 Cash Flow before Financing (2,212) 246.8 (62.4) (125.2) 2.5 Net Financing 1,906 (553.8) (45.0) (45.0) 2.0 Change in Cash (306.3) (307.0) (107.4) (170.2) 1.5 Ratios 1.0 Revenue Growth 129.1% 48.4% -7.0% 13.5% 0.5 Gross Profit Margin 58.3% 78.0% 75.6% 75.6% 0.0 EBITDA Margin 43.1% 59.7% 57.4% 57.4% Effective Tax Rate 37.2% 47.6% 42.3% 40.9% ROE 7.0% 36.9% 4.6% 7.5%
11-Dec-06 11-Jan-07 11-Feb-07 11-Mar-07 11-Apr-07 11-May-07 11-Jun-07 11-Jul-07 11-Aug-07 11-Sep-07 11-Oct-07 11-Nov-07 11-Dec-07 ROAIC 10.7% 19.8% 16.5% 20.2% Dividend Payout Ratio 47.3% 6.1% 41.0% 24.2% Net Debt (Cash) 1,498(8.3)(316.4) (711.0) Net Debt (Cash)/BV 90.9% -0.4% -13.2% -27.9% Net Debt / EBITDA 3.8(0.0) (0.4) (0.9) EBITDA/Net Interest Expense (5.8) (9.5) (29.2) (67.7) Prices as at 11 December 2007 Source: Aabar, EFG-Hermes estimates
Abid Riaz Mohammad Madani uae research yearbook 2008 80 +971 4 363 4005 +971 4 363 4003 [email protected] [email protected] 2007: divestment 2008: tighter strategy uae research yearbook 2008
background Aabar was established in March 2005 with the aim of investing in or partnering with oil and gas companies across the globe to create a diverse portfolio of strategic energy assets. Listed on the ADSM in April 2005, it began operations with Dalma Energy, a drilling company with 22 rigs across the Middle East and India. In 2006 it acquired Singapore-based Pearl Energy, an oil exploration and production (E&P) company that operates throughout Southeast Asia. In July of this year, Aabar announced the sale of Dalma and changed its own name to Aabar Energy. 2007 - sale of dalma energy
After reviewing its long-term strategy earlier this year, Aabar decided to focus on the upstream oil and gas sector, building on its core exploration and production (E&P) business. This has led it to divest its drilling services subsidiary, Dalma Energy, which it sold for AED1.64 billion, which included AED587 million of debt. This represents an implied equity value of AED1.05 billion and therefore a healthy premium to the AED367 million that Aabar had paid for this business back in July 2005.
Aabar meanwhile reported strong 3Q2007 revenues, up 83% Y-o-Y, with the company benefiting from a combination of increased production (to 19,932 barrels of oil per day from 11,229 at the beginning of the year), and higher oil prices during the quarter. However, higher depreciation and depletion costs (associated with higher production levels), coupled with higher-than-anticipated minority interests, held back net income for the quarter. 2008 - focus on upstream beyond south east asia
Given Aabar's new focus, the divestment of Dalma will give the company ample firepower (of over AED1 billion in cash, before any debt financing) to strengthen its current operations by acquiring new companies/entities or production fields in the upstream oil and gas sector. Indeed, Aabar has announced plans over the longer term to develop Pearl's Southeast Asian portfolio and to invest in new opportunities across MENA. Part of this strategy includes the potential swap of key acreage with partners in these areas, a move that in our mind would give the company a key competitive advantage. We believe its clearer focus and its ability to make use of its strong existing portfolio to gain access into areas/regions where it is not now present will place Aabar in a good position in 2008 to embark on a new leg of growth. recommendation We believe Aabar achieved a healthy premium on its sale of Dalma Energy and in doing so has bolstered its long-term strategy of focusing on the upstream oil and gas sector. We nonetheless wait for positive news flow on future acquisitions as it makes use of its new cash pile. This, we believe, could trigger an upgrade in our ST Neutral recommendation.
Our LT Accumulate recommendation is based partly on the relative strength going forward of its operations in Southeast Asia, which look promising in terms of new discoveries following its successful exploration and its production increases in 1H2007. Moreover, its strategy to offer value-added, technology-intensive processes implemented by a well recognized and strong management team gives us confidence that the company can continue to create shareholder value from both existing operations and any future acquisitions.
energy | aabar energy 81 aramex
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Accumulate Current Price: AED 3.20 Assets LT Rec. Buy LT Fair Value : AED 3.72 Cash and Time Deposits 223 256 346 466 Accounts Receivables 262 314 393 492 Inventory - - - - Other Current Assets 788695 104 Stock Data Net plant 128142 161 185 Last Ex-Div Date AED0.1 on 17 Apr 2007 Intangibles 807 807 807 807 Mkt Value (Local mn) AED3,520 Other Long Term Assets 14 14 14 14 Shares (mn) 1,100 Liabilities and Equity Av. Mthly Liquidity (mn) AED504.6 ST Debt 36 13 59 86 52-Week High/Low AED3.35 / 1.70 Payables & Suppliers 118131 164 206 Bloomberg/Reuters ARMX UH / ARMX.DU Other Current Liabilities 137 204 223 246 Est. Free Float 80% Provisions - - - - Long Term Payables 31 32 34 36 (AED) 2006a 2007e 2008e 2009e LT Debt 24 30 40 51 EPS (Attrib.) 0.09 0.11 0.15 0.20 Minority Interest 19 3863 97 EPS (Attrib.) Growth 16.4% 28.6% 32.1% 33.6% Net Worth 1,148 1,171 1,232 1,348 P/E (Attrib.) 37.0 28.7 21.8 16.3 Balance Sheet Total 1,512 1,620 1,816 2,070 Income Statement DPS - 0.09 0.09 0.09 Revenues 1,364 1,766 2,209 2,765 Dividend Yield 0.0% 2.8% 2.8% 2.8% Gross Profit 619.8 826.4 1,034 1,294 SG&A (294.9) (381.8) (468.5) (574.6) BVPS 1.15 1.06 1.12 1.23 EBITDA 133.0 181.4 236.2 307.6 P/BV 2.79 3.01 2.86 2.61 EBIT 108.2 145.5 196.1 261.8 Net Interest Income (Expense) 5.3 4.85.7 7.6 CFPS (Operating CF) 0.14 0.14 0.180.24 Other Income (Expense) - 3.0 0.9 1.1 P/CF 23.1 22.2 17.4 13.4 FX Gains (Loss) - (1.2) (1.7) (2.1) FCF Yield 0.4% 0.3% 2.5% 3.4% Extraordinary items - - - - EV/EBITDA 22.7 18.4 13.9 10.4 Net Income before Taxes 113.4 152.1 201.0 268.4 EV/Capacity N/A N/A N/A N/A Taxes (4.4) (10.6) (14.1) (18.8) Net Debt (Cash) / Mkt Cap -6.2% -6.4% -8.7% -11.8% Net Income after Taxes 109.0 141.5 186.9 249.6 Minority Interest (13.8) (19.0) (25.1) (33.5) Net Attributable Income 95.2 122.4 161.8 216.1 Dividends - 100.0 100.0 100.0 4.0 Cash Flow Statement Cash Op. Profit after Tax 133.9 175.0 225.4 292.9 3.5 Cash Flow after change in WC 71.5 92.4 188.0 246.5 3.0 Capital Expenditure (212.9) (79.5) (99.4) (124.4) 2.5 Free Cash Flow (141.4) 13.0 88.6 122.1 2.0 Non-Op. Cash Flow 7.831.9 39.5 52.8 Cash Flow before Financing (133.6) 44.8 128.1 174.8 1.5 Net Financing (11.9) (11.4) (38.3) (54.4) 1.0 Change in Cash (145.5) 33.4 89.9 120.4 0.5 Revenue Growth 59.7% 29.5% 25.1% 25.2% 0.0 Gross Profit Margin 45.4% 46.8% 46.8% 46.8% EBITDA margin 9.8% 10.3% 10.7% 11.1% Effective Tax Rate 3.9% 7.0% 7.0% 7.0%
11-Jul-07 ROAE 8.7% 10.6% 13.5% 16.7% 11-Jan-07 11-Apr-07 11-Jun-07 11-Sep-07 11-Feb-07 11-Aug-07 11-Dec-06 11-Mar-07 11-Oct-07 11-Nov-07 11-Dec-07 11-May-07 ROAIC 9.8% 12.6% 15.9% 18.8% Dividend Payout Ratio 0.0% 81.7% 61.8% 46.3% Net Debt (Cash) (199.0) (225.8) (305.6) (415.0) Net Debt (Cash) / BV -17.3% -19.3% -24.8% -30.8% Net Debt (Cash) / EBITDA (1.5) (1.2) (1.3) (1.3) EBITDA/Net Interest Expense 25.3 37.7 41.4 40.6 Prices as at 11 December 2007 Source: Aramex, EFG-Hermes estimates
Abid Riaz Mohammad Madani uae research yearbook 2008 82 +971 4 363 4005 +971 4 363 4003 [email protected] [email protected] 2007: year of integration 2008: international expansion continues uae research yearbook 2008
background Aramex, the region's leading logistics and courier business, offers a range of transportation services, including freight, express courier and supply chain management. Now operating primarily to, from and within the Middle East and the Indian subcontinent, Aramex seeks to become a leading global transport solutions provider. Its strong management team, use of technology and flexibility has indeed been enabling it to expand its presence across the international logistics market.
Although Aramex currently generates the vast majority of its revenues within MENA, the company in 2006 acquired a logistics business in Ireland, TwoWay-Vanguard, giving it greater exposure to Europe. Its strategy includes seeking further acquisitions, not only domestic players in the region to consolidate its position as the region's leading player, but also companies in both the United States and China to gain a footprint in these two major markets. 2007 - settling in the european business
Revenues for 3Q2007 jumped 25.2% Y-o-Y to AED451.7 million, with double-digit growth seen across all divisions and particularly strong performances from its freight forwarding and logistics services. Operating costs, however, rose 28.3%, driven by the cost-intensive nature of TwoWay's freight-forwarding operations.This, coupled with higher-than-expected taxes and minority interests, meant that net income for the quarter came in below our expectations and led us to reduce our earnings estimates for the year.
Although higher-than-expected costs held back profits in 3Q2007, Aramex, benefiting from the full integration of TwoWay, continued to delivery strong organic growth during the year. Indeed, we believe the company will continue to win market share. We forecast revenues for the whole of 2007 to increase 29.5% Y-o-Y to AED1,766 million and net profits to rise 28.6% to AED122.4 million. 2008 - further acquisitions
With strong economic growth prospects across the region and continued high oil prices, we expect the relatively immature logistics industry to remain buoyant over the next few years and that in 2008 Aramex will further extend its market share.
Further upside potential in 2008 will come from acquisitions, both regionally and globally, with the company focusing in particular on the US and China, we believe. Given the uncertainties in predicting or estimating a possible acquisition in these two countries, however, we have not included these in our forecasts.
In addition, given Aramex's concentration on integrated logistic solutions and supply chain management, we expect these two segments to make an even greater contribution to the business next year. Despite limiting our estimates to organic growth, we still forecast sales and profit growth of 25% and 32% for 2008. recommendation We believe Aramex is a dynamic company with a strong management team and a solid infrastructure on which it can continue to build. With such solid organic growth prospects and the potential upside from acquisitions, both regionally and globally, we believe Aramex will continue to take advantage of a strong underlying market and seize further market share.
Although our DCF analysis gives us an estimated Fair Value comfortably above the current share price, we are mindful of current short- term valuation multiples, which do not look cheap. However, given our expectations for the company's growth prospects (we forecast strong double-digit earnings progression until 2012), we believe it is more appropriate to value the company on a PEG ratio basis. On this measure, Aramex looks attractive against its global peers. Therefore, our recommendation is a ST Accumulate / LT Buy.
logistics | aramex 83 rak ceramics
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Buy Current Price: AED 5.30 Assets LT Rec. Buy LT Fair Value : AED 7.83 Cash and Time Deposits 303 196 226 270 Receivables 896 1,028 1,185 1,414 Inventory 975 1,071 1,221 1,373 Other Current Assets 329 270 191 117 Stock Data Net Plant 1,234 1,210 1,295 1,290 Last Ex-Div Date N/A Investments in Related Activities 80 124 144 168 Mkt Value (Local mn) AED2,466 Other Long Term Assets 7 4 1 - Shares (mn) 465.3 Liabilities and Equity Av. Mthly Liquidity (mn) AED3.0 ST Debt 635 612 818 899 52-Week High/Low AED6.30 / 3.36 Payables & Suppliers 640 449 484 539 Bloomberg/Reuters RAK UH / RKCE.AD Other Current Liabilities 92 114 120 129 Est. Free Float 24% Dividends Payable - - - 51 LT Debt 1,181 1,273 1,149 1,026 (AED) 2006a 2007e 2008e 2009e Other LT Liabilities and Provisions 18181818 EPS (Attrib.) 0.33 0.37 0.49 0.73 Minority Interest 9 13 19 31 EPS (Attrib.) Growth 7.8% 14.0% 33.1% 46.6% Net Worth 1,251 1,424 1,654 1,940 P/E (Attrib.) 16.3 14.3 10.7 7.3 Balance Sheet Total 3,825 3,903 4,261 4,632 Income Statement DPS - - - 0.11 Revenue 1,686 2,144 2,471 2,950 Dividend Yield 0.0% 0.0% 0.0% 2.1% Gross Profit 599.1 652.8 789.4 984.1 SG&A (209.8) (266.8) (321.2) (398.3) BVPS 2.69 3.06 3.55 4.17 EBITDA 389.3 386.0 468.2 585.9 P/BV 2.0 1.7 1.5 1.3 EBIT 185.0 176.5 230.3 327.7 Net Interest Income (Expense) (103.1) (98.3) (101.0) (99.6) CFPS (Operating CF) 0.33 0.280.810.96 Other Income (Expense) 33.1 95.9 124.0 145.7 P/CF 16.2 19.0 6.5 5.5 FX Gains (Loss) 45.2 15.7 - - FCF Yield -16.2% -7.6% -2.1% 3.4% Net Income before Taxes 160.1 189.7 253.2 373.7 Taxes (6.4) (12.9) (16.6) (25.0) EV/EBITDA 10.2 10.89.0 7.2 EV/Capacity* 40.0 41.837.1 32.6 Net Income after Taxes 153.7 176.8 236.6 348.7 Net Debt (Cash) / Mkt Cap 61.3% 68.5% 70.6% 69.1% Minority Interest (2.0) (3.9) (6.5) (11.4) *AED per Sq m of tile capacity at year end Net Attributable Income 151.7 172.9 230.1 337.4 Dividends - - - 50.6 Cash Flow Statement
6.5 Cash Operating Profit after Tax 382.8 373.1 451.6 560.9 Cash Flow after Change in WC 152.3 132.6 388.1 462.5 6.0 Capital Expenditure (453.8) (225.8) (339.6) (276.7) 5.5 Free Cash Flow (301.4) (93.3) 48.6 185.9 Non-operating Cash Flow 37.4 15.7 - - 5.0 Cash Flow before Financing (264.1) (77.6) 48.6 185.9 4.5 Net Financing 347.4 (29.7) (18.7) (142.1) Change in Cash 83.4 (107.3) 29.9 43.8 4.0 Revenue Growth 29.8% 27.2% 15.2% 19.4% 3.5 Gross Profit Margin 35.5% 30.4% 32.0% 33.4% EBITDA margin 23.1% 18.0% 19.0% 19.9% 3.0 Effective Tax Rate 4.0% 6.8% 6.6% 6.7% ROAE 12.9% 12.9% 15.0% 18.8% ROAIC 7.1% 5.5% 6.5% 8.5% 11-Dec-06 11-Oct-07 11-Nov-07 11-Dec-07 11-Jan-07 11-Feb-07 11-Mar-07 11-Apr-07 11-Jun-07 11-Jul-07 11-Aug-07 11-Sep-07 11-May-07 Dividend Payout Ratio 0.0% 0.0% 0.0% 15.0% Net Debt (Cash) 1,512 1,688 1,741 1,705 Net Debt (Cash)/BV 120.1% 117.5% 104.1% 86.5% Net Debt (Cash)/EBITDA 3.9 4.4 3.7 2.9 EBITDA/Net Interest Expense 3.83.9 4.6 5.9 Prices as at 11 December 2007 Source: RAK Ceramics, EFG-hermes estimates
Wafaa Baddour, CFA 84 +20 2 33 32 1163 uae research yearbook 2008 [email protected] 2007: exploring new initiatives to offset margin decline 2008: will it meet expectations? uae research yearbook 2008
background Ras Al Khaimah Ceramics (RAKCEC) is one of the world's leading ceramics makers, with facilities in the UAE, Bangladesh, China, Sudan, Iran and India. It has an annual capacity of 100 million square meters of tiles and 3.0 million pieces of sanitary ware, with almost 68% of its tile capacity and 78% of its sanitary ware capacity in the UAE. Ceramic tiles account for 86% of its revenue and sanitary ware 14%.The GCC accounts for approximately 60% of consolidated revenue, Europe 20% and other Asian markets 10%. RAKCEC's strategy is to: i) increase exports from its UAE facilities, especially to Europe, and ii) expand its production in emerging markets. Consumption in those markets it has entered has been growing by a rapid 7% to 21%. RAKCEC's share of the ceramic tile market is estimated at 33% in the UAE, 16% in Saudi Arabia, 34% in Bangladesh and 60% in Sudan.
RAKCEC recently entered into joint ventures that require low initial investment and generate high returns. These include: i) ceramic- related activities, and ii) construction and real estate activities, in particular the development of residential and commercial units and industrial warehouses. By investing in these ventures, the company aims to maintain earnings growth to offset soaring energy and other raw material prices. 2007 - income from joint ventures largely offsets higher energy costs
RAKCEC started the year with a capacity of 100 million square meters of tiles after having upgraded by 40% in 2006. RAKCEC's 9M2007 revenue jumped 37% Y-o-Y to AED589 million, driven by 30% growth in tile sales volume and a 7% increase in the average price. Tile capacity was 93% utilized in 9M2007: The new UAE factories operated at full capacity, while the utilization at start ups accelerated to 74% in India, 53% in Iran and 47% in China. EBITDA declined by 7% to AED253 million and the EBITDA margin narrowed to 15.1% from 22.7%, due mostly to a sharp increase in energy costs. The company has been unable to find a reliable supply of natural gas to replace the more expensive liquid petroleum gas it now uses in its UAE factories, and energy now accounts for the equivalent of 14% of revenue, up from 10% in 9M2006. At the same time, selling, general and administrative expenses increased to 12% of revenue from 11%.The decline in EBITDA was offset by strong income from joint ventures and other items, which grew to AED83 million from AED35 million in 9M2006, and by foreign exchange gains, which grew to AED21 million from AED3.3 million. Earnings rose 20% to AED126 million.
We estimate that revenue increased 27% in 2007 to AED2.1 billion, the EBITDA margin shrank to 18% from 23% in 2006 and EBITDA declined 1% to AED386 million. We estimate income from joint ventures and other items increased to AED96 million from AED33 million in 2006, leading to 14% growth in total earnings to AED173 million. 2008 - availability of cheaper energy is key
RAKCEC in January 2008 will bring 5 million square meters of new tile capacity on stream in Iran and 2.6 million in Bangladesh, where by mid-2008 it will also bring 0.33 million pieces of sanitary ware capacity on stream.We estimate total tile capacity will increase 14% to 114 million square meters and sanitary ware by 36% to 4 million pieces by end-2008.
We forecast that revenue will increase 15% in 2008 to AED2.5 billion, driven by an increase of 13% in volume and 2% in prices. We expect the EBITDA margin to recover gradually to 19% as RAKCEC switches to natural gas in the UAE complex, which it expects to do in 2008, leading to an estimated increase in EBITDA by 21% to AED468 million. Guided by management estimates, we forecast income from joint ventures and other items of AED124 million.We forecast earnings growth of 33% to AED230 million.While we feel confident in the company's ability to achieve our revenue target, its ability to recover margins and, accordingly, meet our EBITDA and earnings expectations is sensitive to its obtaining cheaper energy in 2008. recommendation We have a ST/LT Buy recommendation on RAKCEC. Our Fair Value stands at AED7.83 per share. Our forecasts are sensitive to RAKCEC's ability to: i) switch to cheaper energy, ii) generate sustainable income streams from joint ventures, and iii) maintain margins in the event of a global slowdown that results in a supply-demand gap.
household goods | rak ceramics 85 air arabia
December Year End (AED mn) 2006a 2007e 2008e 2009e ST Rec. Accumulate Current Price: AED 1.96 Assets LT Rec. Buy LT Fair Value : AED 2.10 Cash and Cash Equivalents 182 3,338 2,706 2,463 Net Accounts Receivables 75 112 139 170 Net Plant 40 180 1,173 1,788 Net Investments 27 13 12 11 Stock Data Aircraft Lease Deposits 26 33 42 52 Last Ex-Div Date N/A Total Intangibles 17 1,745 1,745 1,751 Mkt Value (Local mn) AED9,146.7 Shares (mn) 4,667 Liabilities and Equity Av. Mthly Liquidity (mn) AED5,285 ST Debt - - - - 52-Week High/Low AED1.99/1.02 Due to Related Parties 3 3 4 5 Bloomberg/Reuters AIRARABI UH / AIRA.DU Total Payables 116 152 202 247 Est. Free Float 45% Dividends Payable - 94 102 112 Other Current Liabilities 65 86 114 140 Other Liabilities 10 12 13 16 (AED) 2006a 2007e 2008e 2009e Minority Interest - - - - EPS (Attrib.) 0.05 0.11 0.09 0.10 Net Worth 174 5,073 5,381 5,717 EPS (Attrib.) Growth 223% 120% -0.17% 10% P/E (Attrib.) 40.7 18.5 22.3 20.4 Balance Sheet Total 368 5,421 5,817 6,237 Income Statement DPS - 0.02 0.02 0.02 Total Revenue 749.2 1,120 1,395 1,710 Dividend Yield - 1.0% 1.0% 1.0% Cost of Sales (615.0) (808.5) (1,075) (1,314) SG&A (52.0) (64.9) (86.5) (102.6) BVPS 0.07 0.71 0.780.85 Depreciation and Amortization (6.3) (10.4) (13.3) (20.8) P/BV 26.2 2.75 2.52 2.31 Net Operating Profit 75.9 235.8 220.0 272.1 Investment Income 2.3 0.0 0.0 0.0 CFPS (Operating CF) 0.06 0.06 0.06 0.07 1.3 110.0 151.1 129.2 P/CF 33.6 34.0 31.9 27.3 Net Interest Income (Expense) FCF Yield 0.9% 2.5% -6.2% -1.8% Sundry Income (Parking Charges Waiver) 20.7 31.0 38.6 47.3 Other Income 1.0 - - - EV/EBITDA 23.3 23.6 27.6 22.8 Net Income before Taxes 101.1 376.9 409.7 448.6 EV/Capacity 15.6 14.9 15.3 12.5 Income Tax - - - - Net Debt (Cash) / Mkt Cap -2.0% -36.5% -29.6% -26.9% Net Income after Tax 101.1 376.9 409.7 448.6 Minority Interest - - - - Net Attributable Income 101.1 376.9 409.7 448.6 Dividends - 94.2 102.4 112.2 2.5 Cash Flow Statement Cash Operating Profit after Tax 82.2 246.2 233.3 292.8 Change in Working Capital 40.4 22.853.9 42.5 2.0 Cash Flow after Change in WC 122.6 269.0 287.1 335.3 Capital Expenditure (39.3) (146.1) (1,001) (629.2) Free Cash Flow 83.3 122.9 (713.7) (294.0) 1.5 Non-operating Cash Flow 15.7 (1,687) 34.4 34.7 Cash Flow Before Financing 98.9 (1,564) (679.3) (259.2) Net Financing (16.3) 4,720 47.1 17.0 1.0 Change in Cash 82.6 3,157 (632.2) (242.2) Ratios Net Operating Profit Margin 10.1% 21.1% 15.8% 15.9% 11-Jul-07 11-Dec-07 11-Sep-07 11-Aug-07 11-Oct-07 11-Nov-07 Effective Tax Rate 0.0% 0.0% 0.0% 0.0% ROAE 58.1% 14.4% 7.8% 8.1% ROAIC 55.1% 14.3% 7.8% 8.1% Dividend Payout Ratio 0.0% 25.0% 25.0% 25.0% Net Debt (Cash) (182.2) (3,338) (2,706) (2,463) Net Debt / BV -104.7% -65.8% -50.3% -43.1% Prices as at 11 December 2007 Source: Air Arabia, EFG-Hermes estimates
Abid Riaz Mohammad Madani 86 +971 4 363 4005 +971 4 363 4003 uae research yearbook 2008 [email protected] [email protected] 2007: flying high 2008: regional expansion uae research yearbook 2008
background Air Arabia was set up in 2003 as the region's first low-cost carrier (LCC). Based out of Sharjah under the umbrella of the Department of Civil Aviation and the Sharjah International Airport Authority, it initially flew to Bahrain, Muscat, Damascus, Kuwait and Beirut. After growing strongly over the past few years, Air Arabia recently completed its IPO in March 2007. From its base in Sharjah, the airline currently flies to 37 destinations in the Middle East, South Asia, Central Asia and Africa with a fleet of 11 aircraft.The airline also operates sales shops and provides tourism, air cargo and other complementary services. 2007 - plane purchase and new hub
Air Arabia made considerable progress during the course of the year. Passenger numbers increased significantly, climbing to 2.0 million passengers in the first nine months of the year from 1.7 million in the whole of 2006. Average load factors jumped to 86% in 9M2007 from 80% in 2006, substantially improving margins and thus profitability.
Indeed, Air Arabia's strong 3Q2007 results were significantly ahead of our expectations. Revenues, buoyed by high demand at the end of the summer holidays and the beginning of Ramadan, jumped 65% Y-o-Y to AED369 million. With operating expenses broadly in line with our expectations, net profit for the third quarter was AED165 million, against our estimate of AED74.0 million, prompting us to upgrade earnings 43% for this year and 17% for next.
As part of its expansion plans for its primary hub in Sharjah, Air Arabia announced the purchase of 49 new aircraft for a book value of AED12.85 billion (we assume the planes are priced at AED182 million each, a 30% discount to book value). Another major development was the recent announcement that the airline will establish a hub in the Moroccan capital of Rabat that will allow it to carry passengers to Europe, North Africa and the Middle East. Given the limited detail available at this point, we have not included the Rabat hub in our forecasts. 2008 - further progress and another hub
We believe next year will be another year of progress for Air Arabia. The airline is due to add a further three aircraft to its fleet and is looking to increase both its number of destinations and the frequency of flights on its more popular routes. Therefore, we expect passenger numbers to continue to grow and estimate a 30% increase on 2007 to 3.3 million.
We expect to receive more details on Air Arabia's new hub in Rabat. In addition, we expect the company will announce yet another hub in the next 12 months, possibly in Syria, Lebanon, Jordan or Egypt, that would compliment and connect the Sharjah and Rabat hubs, putting the hub-to-hub flying distance at between four and five hours. This would provide further upside to our current estimates. recommendation Given the under-penetrated nature of its market, the company's operational strengths and practices and the potential upside from its successful existing hub and potential new hubs and acquisitions, we believe that Air Arabia is well placed to become a leading carrier in the region. We therefore have a ST Accumulate / LT Buy recommendation with a Fair Value of AED2.10.
aviation | air arabia 87 dubai investments
December Year End (AED mn) 2006a 2007e* 2008e* 2009e* ST Rec. Reduce Current Price: AED 5.60 LT Rec. Neutral LT Fair Value : AED 3.95 Balance Sheet Cash in hand and at bank 815.7
Investments at Fair Value 894.7
Investments Available for Sale 396.4 Stock Data Last Ex-Div Date AED0.15 at 8 May 2007 Fixed Assets 970.6 Mkt Value (Local mn) 12,152 Total Assets 6,389 9,353 10,840 12,499 Shares (mn) 2,170 Bank Borrowings 681.9 Av. Mthly Liquidity (mn) AED1,807 LT Borrowings and Payables 958.6 52-Week High / Low 6.11 / 3.92 Bloomberg / Reuters DIC UH / DINV.DU Total Liabilities 2,551 4,503 4,503 4,503 Est. Free Float 88.5% Shareholder's Equity 3,838 4,850 6,337 7,995
Income Statement (AED) 2006a 2007e 2008e 2009e Property Revenues 1,135 1,339 1,302 3,128 EPS (Reported) 0.46 0.52 0.54 0.98 Manufacturing Revenues 804.4 1,533 1,916 2,462 EPS (Attrib.) 0.46 0.52 0.54 0.98 FMCG Revenues 72.0 96.1 105.7 116.2 EPS Growth 13.0% 4.9% 80.2% P/E (Attrib.) 12.24 10.83 10.33 5.73 Investment Revenues 259.4 545.9 631.4 730.3 Transportation Revenues 38.4 - - - BVPS 1.77 2.24 2.73 3.44 Intercompany Eliminations -312.7 (386.5) (483.1) (603.9) P/BV 3.2 2.5 2.1 1.6 Total Revenues 1,997 3,136 3,472 5,833
EBITDA (mn) 1,064 1,323 1,519 2,560 EBITDA 1,064 1,323 1,519 2,560 EBITDA Margin 53.3% 42.2% 43.7% 43.9% EBITDA Margin 53.3% 42.2% 43.7% 43.9%
Depreciation 43.6 89.6 116.2 148.0 Net Debt 606.3 Cash 815.7 EBIT 1,017 1,233 1,403 2,412 Net Debt/ Book Value 15.8% EBIT Margin 50.9% 39.3% 40.4% 41.4% Net Debt/ Market Cap 5.0% Interest Expense 68.0 110.8 143.2 143.2
Provisions
FX Gain (Loss)
6.0 Earnings before Taxes 992.8 1,122 1,259 2,269 Taxes 5.5 Net Income after Taxes 992.8 1,122 1,259 2,269
5.0 Profit from Discontinued Operations N/A 87.8 - - Net Profit for the period 992.8 1,210 1,259 2,269 4.5 Net Profit Margin 49.7% 38.6% 36.3% 38.9%
Cash Flow Statement 4.0 Operating Profit before Changes in WC 393.4 614.5 890.2 1,825
3.5 Total Changes in Working Capital (785.5) (1,206) (40.0) (51.4)
Cash Flows From Operating Activities (392.0) (591.5) 850.2 1,773
Cash Flows From Investing Activities (661.4) (555.5) (706.7) (707.3) 11-Feb-07 11-Oct-07 11-Dec-06 11-Mar-07 11-Dec-07 11-Apr-07 11-Jun-07 11-Jul-07 11-Sep-07 11-Jan-07 11-Aug-07 11-Nov-07 11-May-07 Cash Flows From Financing Activities 1,320 261.4 858.0 -
Net Change in Cash 266.7 49.7 1,002 1,066 Prices as at 11 December 2007 *We do not forecast a detailed breakdown of the balance sheet going forward Source: Dubai Investments, EFG-Hermes estimates
Philippe Habeichi, CFA 88 +971 4 363 4104 uae research yearbook 2008 [email protected] 2007: more real estate initiatives 2008: looking for positive surprises uae research yearbook 2008
background Dubai Investments (DI) is a holding company that invests in existing and start-up companies in the UAE. Incorporated in 1995 by the Dubai government and listed on the DFM in 1999, Dubai Investments has expanded its portfolio significantly over time, a reflection of its buy-and-hold approach.Today DI has interests in more than 46 companies, in manufacturing, agriculture, pharmaceuticals, wholesale and retail trade, industrial and commercial property development and transportation. DI is divided into seven operating divisions: Dubai Investments Park (DIP), Dubai Investments Real Estate Corporation (DIRC), Glass LLC, M'Sharie, Dubai Investment Industries, Al Taif Investments and Dubai Investments Financial Services.
Despite the company's broad corporate interests, DI has significant direct exposure to one sector in particular, real estate, through two of its divisions. One, DIP, a wholly-owned subsidiary, has leased 32 square kilometers from the government for 99 years on which it is completing the last phase of a multi-purpose industrial, business, residential and recreational area designed to accommodate companies and their employees who want to work and live in the same area. DI generates revenue through land leases, and starting 2009, it must remit 20% of those revenues to the government. The other division, DIRC, was established in 2005 to allow DI to participate in Dubai's booming real estate sector. Principally a property developer, DIRC currently has one residential, one office property and one warehouse project. 2007 - real estate the main driver
The development of DIRC's projects got well underway during 2007. Also, DIRC recently purchased a large plot of land in Mirdiff that could lead to further development projects down the road. DIRC is also setting up a joint venture with Aqaar Properties to develop Ajman Oasis, a very large mixed-use project in the emirate of Ajman that we expect to create significant value for the company going forward. Moreover, during 2007 DI partnered with Fujairah Investment Establishment (an investment arm of the Fujairah government) to create Al Taif Investment, which has been established to invest in real estate and manufacturing projects in Fujairah.
In terms of its industrial subsidiaries, DI's glass subsidiary proceeded with its ambitious vertical expansion plan and is building a large float glass plant in Abu Dhabi that will have a capacity of 5.5 million square meters, equal to the entire current demand for high end float glass in the UAE.
We forecast FY2007 revenues of AED3,136 million, EBITDA of AED1,323 million and net income of AED1,122 million excluding profit from discontinued operations. We forecast that fully 37% of net income will be accounted for by gains on the (non-cash) revaluation of investment properties. 2008 - what to do with liquidity?
With DI expected to carry out the second tranche of its rights issue in 1Q2008, DI will have significant liquidity at its disposal. We look for further details on Ajman Oasis, the initiation of projects by Al Taif, the announcement of a master plan for the Mirdiff land and for positive surprises on the investments front.
While the DIRC projects will be closer to completion by the end of 2008, we expect the bulk of the associated revenue and net profit to be realized in 2009 as DIC follows the completed contract method of revenue recognition.We look for FY2008 revenues of AED3,472 million, EBITDA1,519 million and net income of AED1,259 million. We forecast that 39% of net income will be accounted for by gains on the revaluation of investment properties. recommendation We value DI using a sum of the parts valuation, with most components valued using a DCF. We estimate DI's real estate properties to be worth approximately AED5.8 billion on a DCF basis: AED3.5 billion for DIP and AED2.3 billion for DIRC (factoring in the Mirdiff land at book value - AED0.6 billion). We value the company's newly formed Glass LLC division at about AED1 billion based on a DCF/exit multiples based on a forecast that sales will double and earnings triple. We value M'Sharie at the midpoint of a range of AED700 million to AED1.2 billion indicated by DI. Finally, we value the remaining three divisions, DIFS, DII and Al Taif, at their book values (total of AED1.5 billion) because they only hold financial assets for investment purposes or their projects are still in their early stages of development. Adding up the value of the seven divisions, adding back the company's cash and stripping out its debt, we arrive at a fair market value for the equity of AED8.6 billion or AED3.95 per share.
With the current share price significantly above our fair market value estimate for the share, we have a ST Reduce recommendation. Over time, however, we believe DI is well positioned to take advantage of opportunities in the UAE due to its large cash and liquidity position and its close association with the Dubai government, which owns 11.5% of the company. Partly due to this association, we believe the likelihood of positive surprises over the long term to be strong and we therefore have a LT Neutral recommendation.
conglomerates | di 89 publications 2007
No. of Issuance Price at Authors Pages Date Issuance ST/LT Rec. LT FV regional strategy Too Far Too Fast Iqbal 05 30-Oct-07 Results Review - 3Q07 Iqbal/Nessim 04 03-Oct-07 Impact of Global Market Turmoil on Arab Markets Khoury/Baddour, CFA/Iqbal 06 02-Aug-07 Results Preview - 1Q07 Iqbal 03 17-Apr-07 gcc economics Reducing the Attractiveness of Speculation Malik, PHD 02 12-Dec-07 Currency Reform Avoided for Now Malik, PHD 02 04-Dec-07 Monetary Union Even More Distant Malik, PHD 02 10-Sep-07 Implications of the Fed Cut Malik, PHD 03 24-Sep-07 Currency Reform Closer (UAE Economics) Malik, PHD 02 15-Nov-07 banking sector Revisiting Forecasts and FVs Post 3Q Madha, CFA 16 06-Dec-07 Taking Stock Madha, CFA 31 04-Sep-07 The Start of Merger Mania? Madha, CFA 09 25-Mar-07 Priced for Value, But Set for Growth Madha, CFA 53 18-Dec-06 National Bank of Abu Dhabi (NBAD) Weak Deposits Require Greater Capital Funding Madha, CFA 02 06-Dec-07 AED23.5 Neu. / Neu. AED24.3 3Q2007 - No Positive Surprise Madha, CFA 02 24-Oct-07 AED24.0 Neu. / Neu. AED19.6 Slow but Steady Madha, CFA 02 04-Sep-07 AED18.85 Neu. / Neu. AED19.63 2Q2007 - Few Positive Surprises Madha, CFA 02 30-Jul-07 AED18.85 Neu. / Neu. AED16.40 1Q2007 Results Boosted, but underlying earnings still strong Madha, CFA 03 08-May-07 AED20.0 Neu. / Neu. AED16.4 Low-hanging Fruit All Plucked Madha, CFA 02 18-Dec-06 AED15.27* Neu. / Neu. AED16.38* Abu Dhabi Commercial Bank (ADCB) Affected by One-Offs Madha, CFA 02 06-Dec-07 AED6.80 Neu. / Neu. AED6.60 Quality Appreciated Madha, CFA 02 04-Sep-07 AED6.15 Neu. / Neu. AED6.05 2Q07 - Mixed Results Madha, CFA 02 24-Jul-07 AED6.94 Red. / Red. AED5.50 1Q2007 Results Madha, CFA 05 20-Apr-07 AED5.90 Neu. / Neu. AED5.50 Has Come Far and Fast, Challenges From Here On Madha, CFA 02 18-Dec-06 AED5.51 Red. / Red. AED4.91 First Gulf Bank (FGB) Upgrades But Share Price Up to Speed Madha, CFA 02 06-Dec-07 AED22.0 Neu. / Neu. AED19.4 3Q2007 - Solid Results Madha, CFA 02 25-Oct-07 AED19.80 Neu. / Neu. AED15.95 Momentum Maintained Madha, CFA/Abu Khalaf 02 04-Sep-07 AED13.75 Acc. / Acc. AED15.95 2Q07 - Strong Numbers to Drive Grade oF LTFV Madha, CFA/Abu Khalaf 02 26-Jul-07 AED14.75 Neu. / Acc. AED13.38 Review of 9M06 Results Madha, CFA0 03 05-Nov-06 AED12.05 Rvw / Rvw Rvw First Rate Madha, CFA 01 08-Dec-06 AED12.00 Neu. / Acc. AED13.38 Emirates NBD (ENBD) More to Come Madha, CFA 02 06-Dec-07 AED13.30 Buy / Buy. AED16.30 3Q2007 - Earnings Engine Powering Up Madha, CFA 02 04-Nov-07 AED15.65 Neu. / Neu. AED11.37 The Birth of a Star Madha, CFA/Abu Khalaf 02 04-Sep-07 AED9.25 Buy / Buy AED11.37 2Q2007 Results - Forging Ahead Madha, CFA 02 06-Aug-07 Emirates Bank International (EBI) 1Q2007 Results Update... Madha, CFA 03 09-May-07 AED9.20 Neu. / Neu. AED10.65 Super Size ME Madha, CFA/Abu Khalaf 02 12-Jul-07 AED9.33 Acc. / Acc. AED10.65 Still Ahead, but the Pack is Close Behind Madha, CFA 02 18-Dec-06 AED10.36* Neu. / Neu. AED10.65* National Bank of Dubai (NBD) Super Size ME Madha, CFA/Abu Khalaf 02 12-Jul-07 AED8.85 Acc. / Acc. AED10.11 1Q07 Results - Numbers Shy of Expectations.. Madha, CFA 02 07-May-07 AED8.95 Buy / Buy AED9.13 Mercury Rising Madha, CFA 02 18-Dec-06 AED7.23* Buy / Buy AED9.45* Commercial Bank of Dubai (CBD) Value Unappreciated Madha, CFA 02 06-Dec-07 AED10.0 Buy / Buy AED13.4 3Q2007 - Steaming Ahead Madha, CFA 02 17-Oct-07 AED9.24 Acc. / Acc. AED9.64 Midmarket Specialist Madha, CFA/Abu Khalaf 02 04-Sep-07 AED8.59 Acc. / Acc. AED9.51 2Q07 - Solid Results Madha, CFA/Abu Khalaf 02 16-Jul-07 AED8.55 Acc. / Acc. AED9.09 Positive Surprise But Slight Erosion of Quality Madha,CFA 05 24-Apr-07 AED7.30 Acc. / Buy AED8.86 Switching on The Turbo Madha, CFA 02 18-Dec-06 AED7.09 Acc. / Buy AED8.61 Dubai Islamic Bank (DIB) Saved by Non-Core Hidden Value Madha, CFA 02 06-Dec-07 AED10.40 Acc. / Neu. AED11.2 3Q2007 - Results Disappoint Madha, CFA 03 14-Nov-07 AED10.70 Red. / Neu. AED9.28 Strategically Speaking Madha, CFA/Abu Khalaf 02 04-Sep-07 AED9.70 Red. / Neu. AED9.28 2Q2007 Results - Foggy but FIne Madha, CFA 02 15-Aug-07 AED9.98 Neu. / Neu. AED8.58 First and Best but Challenges from New Entrants Madha, CFA 02 18-Dec-06 AED7.85* Neu. / Neu. AED8.58* Abu Dhabi Islamic Bank (ADIB) Adrift Madha, CFA 02 06-Dec-07 AED62.70 Red. / Neu. AED56.60 3Q2007 - Yet to Accelerate Madha, CFA 02 31-Oct-07 AED67.30 Neu. / Neu. AED62.53 New Management, New Approach Madha, CFA/Abu Khalaf 02 04-Sep-07 AED55.15 Buy / Acc. AED62.53 2Q07 Results - Strong Revenues ... Madha, CFA/Abu Khalaf 02 30-Jul-07 AED54.85 Neu. / Acc. AED62.49 Building From Within Madha, CFA 02 18-Dec-06 AED56.55 Neu. / Acc. AED62.0 housing finance sector Exceptional Growth But Rich Valuations Madha, CFA 22 10-Dec-07
90 *Prices and FV adjusted for subsequent bonus issues uae research yearbook 2008 No. of Issuance Price at Authors Pages Date Issuance ST/LT Rec. LT FV
Good Value Without Banking Licenses? Madha, CFA 02 02-May-07 In Need of Banking Licenses Arabi/Madha/Khoury 28 11-Jan-07 Amlak Finance Good But Is It Best? Madha, CFA 02 10-Dec-07 AED4.54 Red. / Red. AED3.34 Banking License Rejection Madha, CFA 02 03-Apr-07 AED2.76 Neu. / Red. AED4.52 Seeking the Missing Piece to the Puzzle Madha, CFA/Khoury 02 11-Jan-07 AED5.12 Neu. / Red. AED4.52 Tamweel Rick Pickings Madha/Khoury 02 10-Dec-07 AED6.98 Neu. / Neu. AED7.24 In the Right Place, At The Right time Madha/Khoury 02 01-Jan-07 AED4.17 Buy / Acc. AED4.75 insurance GCC Insurance Primer Madha, CFA 17 10-Oct-07 Islamic Arab Insurance Company (Salama) 3Q2007 - Results Mixed Madha, CFA 03 14-Nov-07 AED3.50 Acc. / Acc. AED3.62 Insurance Nexus Madha, CFA 25 10-Oct-07 AED3.33 Acc. / Acc. AED3.62 telecom Etisalat Balanced Portfolio of Value and Growth Ananian/Ziada 28 05-Dec-07 AED21.90 Buy / Buy AED31.30 3Q2007 - Egyptian Start-up Bites Into Margins Ziada/Ananian 03 17-Oct-07 AED19.10 Buy / Buy AED24.00 1Q07 - Local Operations Surprise... Ziada/Ananian 05 26-Apr-07 AED16.40 Buy / Buy AED23.95 A Growing Appetite for Expansion Darwish 18 10-Jan-07 AED15.32* Buy / Buy AED23.95* du On the Right Track Ananian/Ziada 10 13-Dec-07 AED6.00 Acc. / Acc. AED7.00 2Q07 - Solid Results.... Ziada/Ananian 02 01-Aug-07 AED5.00 Acc. / Acc. AED6.06 Finding Growth in A Mature Market Ziada, Ananian 39 09-Jan-07 AED6.34 Neu./Neu. AED6.06 construction and real estate Hot Market Begins to Cool Kapadia/Schurmann/Khoury 26 24-Sep-07 Emaar Time for A Revival Schurmann 09 15-Dec-07 AED13.70 Buy / Buy AED20.40 3Q2007: Volumes in Line - Margins Below Schurmann 02 17-Oct-07 AED11.80 Buy / Buy AED19.70 Land-Equity Swap Cancelled... Iqbal 02 27-Aug-07 AED10.85 Buy / Buy AED19.70 2Q07 - Sacrificing ST Margins for LT Gains Iqbal 04 17-Jul-07 AED11.55 Buy / Buy AED19.70 Buy Emaar, Pay for Dubai and Get the Rest for Free Gad, CFA 72 10-Jan-07 AED12.70 Buy / Buy AED17.70 Union Properties Closer Look Leads to Rise in Fair Value Kapadia/Khoury 29 09-Dec-07 AED4.82 Buy / Buy AED5.75 3Q2007 - Strong Rise in Selling Prices Drive Upgrade Kapadia 03 30-Oct-07 AED4.19 Buy / Buy AED4.56 2Q07 Results - Still on Track - Lower to Accumulate Kapadia 02 12-Jul-07 AED3.41 Acc ./ Acc. AED3.59 High End But Attractively Priced 34 15-Jan-07 AED2.35* Buy / Buy AED3.60* Arabtec Scaling New Heights Kapadia/Khoury 14 29-Nov-07 AED8.32 Buy / Buy AED10.60 Regional Expansion Gains Momentum 03 13-May-07 AED5.02 Buy / Buy AED7.04 utilities and energy Dana Gas 3Q07 - Iranian Contract Delay Leads to Downgrades Riaz/Madani 10 27-Nov-07 AED1.97 Red. / Sell AED1.46 1Q2007 Results - 80 Days of Centurion Kapadia/Riaz 04 22-May-07 AED1.50 Neu. / Neu.AED1.80 Forecast Upgrades Post-centurion Acquisition Riaz/Kapadia 13 29-Jan-07 AED1.46 Neu. / Neu. AED1.80 Abaar Energy 3Q2007 - Higher Production & Revenue Riaz/Madani 03 31-Oct-07 AED4.25 Neu. / Acc. AED3.75 Change to Forecasts Post Dalma Sale Riaz 12 13-Sep-07 AED3.61 Neu. / Acc. AED3.75 2Q07 Results - Tighter Strategy ... Kapadia/Riaz/Madani 02 01-Aug-07 AED3.62 Buy / Acc. AED3.72 1Q2007 Results Riaz/Kapadia 03 22-May-07 AED2.56 Buy / Acc. AED3.22 Pearl: A Real Gem Riaz/Kapadia 30 15-May-07 AED2.58 Buy / Acc. AED3.22 Tabreed Changes to Forecasts Leads to Higher FV Riaz/Madani 10 14-Nov-07 AED3.17 Acc. / Buy AED4.19 2Q07 Results - Below Expectations ... Riaz/Kapadia 02 30-Jul-07 AED2.56 Acc ./ Buy AED3.69 1Q2007 - In Line Riaz, Kapadia 03 30-Apr-07 AED2.09* Acc. / Buy AED3.70* FY2006 Results Riaz/Kapadia 07 17-Apr-07 AED1.86* Acc. / Buy AED3.70* other Aramex 3Q2007 - EPS Downgrade but Slight FVUpgrade Riaz/Madani 07 05-Nov-07 AED3.15 Acc. / Buy AED3.72 2Q2007 Results - Strong Quarter, On Track for FY2007 Kapadia/Riaz/Madani 02 07-Aug-07 AED2.53 Buy / Buy AED3.50 Full Speed Ahead Riaz/Kapadia 05 02-Apr-07 AED1.72* Acc. / Buy AED3.27* 1Q2007 Results - Ahead of Expectations Riaz, Kapadia 08 13-May-07 AED1.99* Buy / Buy AED3.18* Rak Ceramics Exploring New Initiatives to Offset Margin Decline Baddour, CFA 03 09-Oct-07 AED5.70 Buy / Buy AED7.83 Air Arabia Strong 3Q07 - Leads to Significant Upgrades Riaz/Madani 13 22-Nov-07 AED1.82 Acc. / Buy AED2.10 Priced so That You Can Fly Riaz/Kapadia 39 28-Jun-07 AED1.02 N/R/N/R N/R Dubai Investments Overpaying For Liquidity Habeichi, CFA 21 04-Dec-07 AED5.40 Red. / Neu. AED3.95 *Prices and FV adjusted for subsequent bonus issues uae research yearbook 2008 91 efg-hermes.com efg-hermes (egypt) 58 el tahrir st dokki giza 12311 egypt tel +20 2 33 32 1140 fax +20 2 33 36 1536 efg-hermes (uae) level 6 the gate west wing difc dubai tel +971 4 363 4000 fax +971 4 362 1170 efg-hermes (ksa) kingdom tower 22nd floor riyadh saudi arabia tel +9661 211 0046 fax +9661 211 0049 bloomberg efgh reuters pages .efgs .hrms .efgi .hfismcap .hfidom