JAN 2021

Outlook on MENA

RD32592

Summary• MENA equities were dominated by the effects of

the COVID-19 pandemic during 2020, with domestic governments taking unprecedented economic measures to support their respective economies.

• During lockdown periods, stockpiling of necessities, digitisation, and e-commerce became key themes, as consumers purchased goods using e-commerce platforms.

• We view our strategy as well positioned to benefit from a rebound in the global economy and demand in 2021. We continue to favour the markets and companies trading at attractive multiples, while being selective and cautious about the universe of companies that look expensive on an absolute and relative basis.

2020 was challenging for populations across the globe, with the COVID-19 pandemic wreaking havoc for the majority of the year. Since it began, we witnessed restrictions varying from domestic curfews to national lockdowns and global shutdowns, impacting logistics and travel among other things, as countries struggled to contain the virus. The Middle East and North African (MENA) region was not untouched by the pandemic and was quick to react to the situation. While the markets had started 2020 on a strong footing with sound economic data providing the perfect platform for growth, the lightning pace of the virus spread surprised markets and resulted in a broad-based sharp decline. This led domestic governments to take unprecedented economic measures to support their respective economies.

During the early days of the pandemic governmen moved swiftly, providing relief measures by way of loan deferments, fee waivers, liquidity-enhancing measures such as zero-cost deposits, and in certain cases, operating expense-related subsidies by way of salary support for citizens.

The MENA region saw its population shrink over the year, mainly on the expat front, and especially in countries where this constitutes a large portion of the population. This occurred for various reasons, including job losses as the pandemic tightened its grip globally. During this period, stockpiling of necessities was also a common theme, with the markets rewarding the sectors with inelastic demand, such as consumer staples. The sudden boost in e-commerce and digitisation efforts saw some consumer discretionary names adapting to the situation and finding favour among investors.

In terms of market performance, interest rate cuts and a significant influx of liquidity through zero-cost deposits resulted in increased trading activity in the MENA region, in line with what was witnessed globally. This resulted in Saudi Arabia and Qatar recovering quickly and recouping the initial losses to become the best-performing regional markets.

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Country FocusSaudi Arabia 2020 began on a strong footing for Saudi Arabia, backed by a strong set of economic data. However, the fast spread of the virus brought an abrupt halt to all economic activity along with curfews and eventually a lockdown by the end of the first quarter of 2020. Investor fears led to a steep decline in the markets. During the lockdown, stockpiling, digitisation, and e-commerce became the key theme, as consumers piled up on necessities using e-commerce platforms. In order to curb the rising deficit and the cost to the exchequer, the government announced a VAT increase from 5% to 15%, along with a hike in custom duties on most products, while also rationalising yields on mortgages.

Swift action by the government in providing deferrals and relief measures targeted at the Small and Medium Enterprises (SME) sector along with interest-free deposits at banks helped alleviate any concerns regarding domestic liquidity. With the opening up of the economy during the second half of the year and the swift response of the government to the pandemic, economic activity returned with strong cement sales, upbeat lending data backed by the high-yield mortgage segment and low cost of risk in light of economic recovery, and strong consumer spending in the discretionary sector, to name a few.

Despite the wider fiscal budget deficit of 12% of GDP achieved in 2020, the government is budgeting a 7% year-on-year cut in spending for 2021 as it is sticking to its plan to narrow the fiscal deficit with an eye on a balanced budget by 2023. Most of the spending cut is going to be recorded in capital expenditure, reinforcing the role of the Public Investment Fund (PIF) in shaping the Kingdom’s future growth and driving the capital expenditure programme through the previously announced mega projects. From that perspective, the PIF announced that it plans to invest SAR150bn ($40bn) annually in the local economy over the next two years, compared to SAR58bn in 2019. On the revenues side, the government seems to have built its budget based on an oil price of $45 a barrel, which seems conservative and leaves room for upside. Revenues in 2021 are expected to increase 10% on the back of taxes on goods and services related to the tripling of the VAT and the increase in custom duties. Overall, the budget seems to be expansionary, especially given the PIF’s pushing ahead with its ambitious spending plan. It would be interesting to see whether this shift in the development model, where the PIF’s spending compensates for the sharp fiscal retrenchment and reduced capex by the central government, proves to be effective in driving the economy in the right direction.

While Saudi Arabia traded in positive territory during 2020, we believe the strong performance has been a result of factors beyond fundamentals, such as low interest rates, excess systemic liquidity, and COVID-related one-offs including lack of travel, that fuelled domestic spending. The recovery is expected to be gradual in our opinion, and 2021 might not witness growth across all the sectors. To put things into perspective, the Tadawul Index is currently trading at near 20x forward PE as against its historic average of 14x.1 As such, for market outperformance to continue we strongly believe the market should either re-rate, which is least likely given the already expensive multiple,

or the economy witnesses a V-shaped recovery fuelled by government-backed spending. This in turn will depend on government budgets, oil prices stabilising, and a vaccine being fully rolled out.

We continue to focus on the steep rise in debt-to-GDP in Saudi Arabia, which is expected to reach 34% by 2021, against less than 10% just five years ago.

UAE UAE markets, which are trading at relatively attractive multiples (especially Dubai which is trading at a PE of 10),2 were hit hard by the pandemic. While the government moved quickly to allay investor concerns with economic support and stimulus packages, the fact that a major portion of the economy is exposed to external shocks did not help. For example, Dubai’s economy is largely driven by tourism, hospitality, and trade, which have been badly impacted by the COVID-related restrictions. Furthermore, Dubai’s real estate is relatively more exposed to expat investments as compared to Abu Dhabi, which made matters worse. Having said that, we believe the nimble-footed action by the federal government, and the strong recovery since opening up the economy, positions Dubai to be amongst the first economy to be out of the woods once vaccines are ready for mass distribution. We believe aviation, hospitality, and retail will be the key beneficiaries as global economic activity picks up, given Dubai’s high rank among top travel destinations.

On the other hand, we believe Abu Dhabi, with its deep pockets, has shown strong leadership in terms of support to the entire UAE economy. The government will lead on spending in key domestic industries such as trade, logistics, staples, and hospitality, backed by its 100 years of oil reserves. In recent times, the central bank extended the loan deferrals supporting SMEs and individual clients until the first half of 2021, backed by zero-cost deposits with the banks, thereby further cushioning the hit to the business sector.

In a nutshell, sustained backing by the government, strong capital buffers with the banks amidst controlled asset quality deterioration, and a pick-up in economic activity per the PMI index indicate, the UAE is well positioned to recover and grow its economy. The same will likely be reflected in the market as it re-rates from current single-digit PE multiples.

Qatar Despite an environment of low oil prices and the global pandemic, the country managed to maintain a twin surplus with its prudent expenditure policies, in line with the current situation. Thus, its stock market has outperformed the benchmark, given capital flight towards more defensive markets. Per estimates, the country has an accumulated buffer of US$320bn (165% of GDP)3 in its sovereign wealth fund. The country has made conscious efforts to diversify its economy away from oil and over the long term expects domestic production of key food items to increase, in light of the embargo from neighbouring Gulf states. During this challenging period, the government ensured investments into key infrastructure projects, which helped boost the economy and supported market outperformance. In addition, a medium-term catalyst will be the FIFA World Cup in 2022. Over the long term, Qatar is investing into enhancing its production of

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liquefied natural gas (LNG) in the North Gas Field by 30% by 2025 and 67% by 2030, which should help reduce the fiscal breakeven oil price from $53 to $42 a barrel and external breakeven down from $58 to $48 per barrel.4

As stated above, we believe the market currently has priced in the positives, as it trades at over 18x its forward PE, against a historic average of 12.5x, mainly backed by liquidity and a low interest rate environment. A potential resolution of the political and economic blockage of certain GCC countries on Qatar could also be taken positively by the market, even though the government has built a self-sustained and independent type of economy over the years since the embargo began.

Kuwait Historically, Kuwait’s economy suffered from the political deadlock between the parliament and the government, with project execution rates hovering at around 48%.5 Given the pandemic and the resultant low oil prices, the fiscal deficit for 2020 is predicted to reach 14% of GDP. The country witnessed another deadlock over passing regulation to increase the country’s debt limits, thereby negatively impacting liquidity. The recent parliament elections resulted in an increased participation from opposition members which suggests that passing new and much-needed reforms will remain difficult and could lead to increased fiscal austerity.

During the year, Kuwait witnessed a smooth transition of its rule to the new Emir, which was well accepted by the markets. The country’s inclusion into the MSCI Emerging Markets Index provided further impetus to the market, as many investors built up positions in the likely large-cap names ahead of the move. With the benchmark inclusion behind us, and given a widening fiscal deficit and the government’s inability to provide funding, concerns will likely rise over whether the market can maintain its current expensive valuation.

Oman Oman was the worst-affected economy by the pandemic with a high oil breakeven price and debt-to-GDP close to 80%, up 20% year over year. To further aggravate the situation, the country witnessed a sharp decline in its sovereign wealth fund and a fiscal deficit that reached 17% in 2020.6 In light of this, we believe the country needs to raise further debt along with privatising vast government-owned entities, or at least reduce government stakes in many listed entities. All that said, Oman is well positioned politically to get financial support from the GCC partners and other neighbouring countries, with Qatar recently depositing $1 billion in the banking system to enhance the country’s liquidity requirements.

Over the last few years, the government increased its investments into infrastructure, undertaken fiscal reforms, and reduced subsidies, which should help boost revenues over the medium term. Furthermore, many of these steps undertaken were used to attract foreign direct investment (FDI) into the energy and petrochemicals sector, and in the Duqm project alongside investment from China. However, given the pandemic, we believe the benefits will be delayed as some investments were postponed.

We believe valuations are too attractive to be ignored with the Omani market trading at a PE of 9x, but the near-term macro concerns continue to pressure the economy. We thus approach the market selectively, focusing on high-quality names that we do not believe deserve such a large discount.

EgyptEgypt was the only country within the MENA universe that saw positive growth in 2020 and is even expected to post real positive growth for 2021, as the country seems to have done an excellent job implementing its International Monetary Fund (IMF) programme. Egypt’s stimulus packages provided a much-needed cushion for private spending and demand, driving positive GDP growth. Inflation numbers were well contained during the year, averaging around 6% and within the central bank zone of 9% (+/-3%). With the steady, lower inflation rates accompanied by carry trade inflows, given Egypt still offers the highest margin of real interest rates, rates are expected to continue their downward trajectory, on top of the 400 bps rate cut seen in 2020. This backdrop should be conducive for a stable currency, in addition to a pick-up in the capex cycle for corporates which lagged in recent years, given the historical high interest environment. Overall, this should be positive for banks and should translate into higher lending activity for corporates in general. Furthermore, we are positive on the healthcare, services, and consumer sectors, where a lack of penetration has been a common theme. Stock selection within these sectors is key to finding the right opportunity at the right valuation.

MENA Market Could See Rotation in 2021Within MENA, we have seen the development of two different universes of stock markets. The first is expensive, such as the markets of Saudi Arabia, Kuwait, and Qatar, which continues to attract buying activity and thus outperforming. The second is deep value, mainly Dubai and Oman, which continues to be neglected and trading at cheap multiples.

Within this backdrop, we see two possible scenarios. One scenario would translate into continued outperformance of expensive markets, which would become even more expensive. Here we would need to see corporate earnings growing enough to justify the already high multiples. Another scenario would be where the cheaper markets start to attract buying interest from investors, which would translate into the re-rating and rotation of the overall market. We see the second scenario as more probable, especially if this is combined with a strong rebound in economic activity in lagging markets (such as Dubai) supported by vaccine developments.

Accordingly, we believe that our strategy is well positioned to benefit from a rebound in the global economy and demand in 2021, and its resulting effect on MENA markets. We continue to favour markets and companies trading at attractive valuations, while being selective and cautious about the universe of companies that look expensive on an absolute and relative basis.

Outlook on MENA

This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

Notes1 As of 31 December 2020. Source: FactSet, LAM Research

2 As of 31 December 2020. Source: FactSet, LAM Research

3 As of 31 December 2020. Source: SWF Institute

4 As of 13 November 2020. Source: S&P Global and LAM Research

5 As of December 2020. Source: EFG Hermes Research

6 As of December 2020. Source: IMF

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