Saudi banks and petchems seen as popular play

Investors stand in front of a screen at the Tadawul stock exchange in Riyadh. Bank of America Merrill Lynch has cited banks and petrochemical companies among its top investor picks in Saudi Arabia. (Reuters)

LONDON: Bank of America Merrill Lynch (BAML) has given the Saudi Arabian stock market a huge vote of confidence in its latest report in which banking and petrochemicals were its top-rated sectors.
“We highlight Al-Rajhi and Samba as our top picks among the banks and Yansab and SABIC among the petchems,” says BAML.
They are expected to benefit from strong projected earnings, free cash-flow, attractive valuations and dividend yields, the report said.
Banking and petrochemicals (petchems) are viewed as sectors that will benefit most from the Kingdom’s 2018 budget and the reform program introduced by Crown Prince Mohammed bin Salman.
Elsewhere BAML takes a more selective approach because of inflationary pressures on operating costs such as expat levies and rising utility costs.
In the consumer space, Jarir was its top pick, Zain KSA among telecommunications companies and Al-Hammadi within health care.
BAML added: “We also see support for the larger cap/ higher quality names coming from Saudi Arabia’s potential inclusion in the MSCI Emerging Markets Index and the FTSE Emerging Markets Index.”
It highlighted manufacturing company SABIC and NCB (National Commercial Bank) as its top picks here (both Buy rated, that is the companies shares have been rated as worth buying).
“Other companies (where we do not have coverage or have coverage but not a Buy rating) that could benefit from such support include: STC (Saudi Telecom Company), Almarai, Ma’aden, Saudi Electricity Company (SECO), Al Rajhi Bank and a multitude of petrochemical companies.”
Its positive forecast for banks flows is due to factors such as providing subsides to facilitate home ownership and enable real-estate financing, and a stimulus/loans package designed to develop the private sector.
More generally, BAML said it remains positive on the KSA market, given attractive valuations.
Other bullish factors were that “the market is also trading at an 11 percent discount to its longer term average; improving fundamentals, with earnings upgrades outpacing downgrades and a more robust oil price outlook; the prospect for accelerating growth in the non-oil economy coming on the back of reform programs and an expansionary budget.”
BAML said that Saudi Arabian corporates have started to raise dividend pay-outs. Dividends for MSCI constituents grew by 8 percent in 2017, with banks leading the way with a 75 percent increase in dividends in the first half of 2017.
The report said that consensus data from Bloomberg suggests that in 2018 market free cash flow (FCF) generation would improve by 25 percent (largely led by petchems/ materials and banks), supporting a 20 percent increase in gross dividends.
The Saudi Arabian economy was said to be undergoing an unprecedented transformation, with the government seeking to reduce its reliance on oil revenues. “Ultimately, we see this as increasing the sustainability of economic growth in the longer term, potentially underpinning a rerating in the Saudi market.”
To achieve the government’s objectives, BAML said that a number of measures were being implemented. These include: Pursuing significant fiscal consolidation (subsidy reductions, expat levies and introduction of VAT); growth measures for the non-oil economy and the private sector (for instance the move to grant women driving licenses); a widespread privatization program (including the well documented, potential initial public offering of Aramco); and a focus on attracting foreign direct investment, according to the report entitled, ‘Saudi Arabia: growth bull, fiscal bear’.
On the fiscal side, BAML said that the Kingdom’s decision to introduce reforms more gradually, highlighted by the Royal Order of January which offered more financial support for Saudi consumers, meant that fiscal stability was now assured at an oil price of about $60 per barrel (bbl). Before the order, the oil price could have fallen to around $50/bbl and the fiscal imbalance would still have been in mid-single digits.
BAML added: “With the January 2018 Royal Order, the fiscal breakeven oil price hovers now around $90/bbl, against $85/bbl prior to the order.”