Saudi stock market correction to be ‘sharp and painful’

DISPROPORTIONATE valuations of listed companies in Saudi Arabia are making a “sharp and painful” correction in the region’s most capitalised market all the more likely, according to Japanese investment bank Nomura.

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By  Massoud A. Derhally Published  July 3, 2005

DISPROPORTIONATE valuations of listed companies in Saudi Arabia are making a “sharp and painful” correction in the region’s most capitalised market all the more likely, according to Japanese investment bank Nomura. Tarek Fadlallah of Nomura cautioned that investors in Saudi Arabia should look for more conservative investments that may serve them better in the long term. “The markets are overvalued and can continue to be rewarding in the short term,” Fadlallah told Arabian Business. “Bank deposits over the next 18 months will be much more rewarding than investing in Saudi stocks because Saudi stocks will go down,” he added. Fadlallah, who heads institutional sales at Nomura in the Middle East, said the prevailing assumption in the Gulf countries of a direct correlation between higher oil prices and corporate valuations was leading to a credibility gap. Valuations, he said, should instead be driven by earnings and dividend payouts. “The mismatch in performance between profits and the stock market has led valuations to expand just at the point in cycle when they ought to be compressing in anticipation of slowing growth,” Fadlallah wrote, in a recent report. Fadlallah highlighted the hyper-valuation of Saudi Telecom, whose market capitalisation of US$74 billion is larger than the combined value of British Telecom (US$35 billion), America’s AT&T (US$15 billion), South Korea’s SK Telecom (US$15 billion) and South Africa’s Telekom SA (US$9 billion). “To me it seems rather strange that you have a situation where the oil sector, which is what Saudi Arabia is all about, is unlisted and major companies are also largely unlisted — and despite that other companies that are listed still account for 150% of the GDP of Saudi Arabia,” Fadlallah said. “If you were to capitalise the value of the oil industry, like the state-owned Aramco and some of the big family companies, you could actually double, triple or quadruple the market cap of Saudi Arabia. You are then telling me that a country that has a GDP of US$300 billion has got a market cap which is equivalent to one third or even half of Japan’s market cap and that just doesn’t make sense. You can feel something is wrong there,” he added. Regionally, what is equally alarming, Fadlallah said, is the aggressive rate of lending and the high rate of debt that is being accrued by businesses and individuals. This increases the exposure of financial institutions and amplifies the risks to investors. “UAE banks are lending to asset-based businesses, which is creating a lot of liquidity that is going into the same properties that everyone is vying for. So they are bidding up for properties and the collateral they are using is those properties whose prices are going up on a day-to-day basis. It’s the exact signs of a bubble because it feeds upon itself,” said Fadlallah. “People will say I’ll lend you a US$100 million because you have a building that is worth US$100 million. A month later it’s worth US$200 million. You go to the bank and ask for another $100 million because your building has gone up in value and you want to redevelop a piece of land you bought. The bank gives you money and is very happy because its making its cut and you’re very happy because you’re assets are increasing and prices are going up,” explained Fadlallah. But at some point, he cautioned, that pyramid scheme has to come to an end. “When that happens, if you think about the unwinding process involved in that, that’s where the danger comes in. When the US$200 million property, which you are fully leveraged against, becomes worth only US$100 million … your bank needs the money back and you can’t pay them,” Fadlallah added.

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