Middle East equity research poll 2007: Award Winners
AT THE BEGINNING of May, stocks on the Bourse de Casablanca were trading on an average of 22 times earnings, the highest P/E ratio in the region. It was the end of a long bull run. But even as prices began to fall, most of the research in the country continued to be overwhelmingly positive about company prospects, and in some cases was even more positive than before. Morocco, with only a handful of local banks producing at best acceptable research, is perhaps a far-flung example. Even so, throughout the Middle East and North Africa region, truly balanced research of the kind expected in more established financial centres is still elusive. “You hardly ever see ‘sell’ recommendations. Any time you see a rating of ‘hold’, that is a sort of nice way to say ‘sell’. Most investors understand that,” says Khaled Majeed, founder and investment manager of London-based Mena Capital, a fund that invests solely in the Middle East and North Africa region. According to Raed Zawaideh, a trader at state-owned government fund the Abu Dhabi Investment Authority (Adia), less than 5% of research in the region is negative. When markets in the Middle East start to plunge, as many of them did in 2005/06, much of the research simply dries up, says Zawaideh.
Part of the problem is that an investment culture based on research is a relatively new concept in the Middle East. Industry insiders say that brokers only started to develop research capacity about three years ago. Good-quality, up-to-date research that went beyond the basic, publicly available facts and figures, they say, only started emerging in the past one to two years.
Foreigners raise the game
Even now, “if you want to invest in a company, it’s far from guaranteed that there will be a report out there that would cover it, dated as it should be, and with quarterly results,” says Joe Kawkabani, head of equity asset management at Dubai-based emerging markets specialists Algebra Capital.
However, since the 2005/06 regional stock-market crash, and, more fundamentally, since many of the markets in the region became more accommodating to international investors, more of the global investment banks have been attracted to the region, and the locals have been forced to start to raise their game. Research departments in the past few years have gone from having just one or two analysts to having seven, eight, and, for the larger brokers, sometimes even 30 or 40. Banks in the region are tripping over themselves to attract internationally trained talent. As a result, salaries have rocketed. According to Mena Capital’s Majeed, an analyst who earned $100,000 four years ago could be earning $500,000 now.
The fact that research still leaves a lot to be desired in much of the Middle East cannot, however, be attributed simply to demand for analysts outstripping supply. A telling point is where the good research is to be found. In markets such as Egypt and Kuwait, which have welcomed international investors for longer than many regional markets, institutional investors and demand for research are more established. This is reflected by the dominance of Euromoney’s Middle East research poll by Global Investment House, a Kuwaiti bank, and EFG-Hermes, an Egyptian broker. These are the only two local firms to provide good-quality research outside their home markets; and that is because demand for research is a much older feature of the capital markets in their countries. Research in countries such as UAE, Qatar and Oman has improved with the liberalization of their economies. Saudi Arabia, however, the region’s biggest market, is still lagging behind, industry participants say, simply because the equity market has so far been closed to international investors, limiting the operations of the global investment banks.
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“A lot of the management were aware that the stocks were overvalued, and so until recently they questioned the interest of meeting with analysts. They knew it was not going to make a positive difference to their share price” |
Philip Khoury, head of research at EFG-Hermes, is perhaps typical of the new generation of Middle Eastern researchers. Previously an equity research analyst for Merrill Lynch in London, he joined EFG-Hermes in 2002. He says that the global banks did have more extensive research capacities in some parts of the Middle East (especially in Egypt and Kuwait), but this almost disappeared after the corrections in global stock markets at the beginning of the decade. With HSBC the only international bank to properly sustain its research in the region, he says, local banks such as EFG-Hermes were left to fill in the gap, and then expand into the Gulf, which has since become the centre for international investment in the region. Analyst avoidance
Khoury and his counterpart at Global Investment House, Faisal Hasan, admit that good research has been difficult to produce in part because, until recently, companies’ management were still wary of even meeting analysts. Khoury says: “A lot of the management were aware that the stocks were overvalued, and so they questioned the interest of meeting with analysts. They knew it was not going to make a positive difference to their share price.”
However, with share prices having fallen in the past 18 months, meetings between researchers and companies’ management are becoming more frequent and more productive. “These companies have started to realize that there is a benefit to being more open,” says Khoury. Indeed, according to Global Investment House’s Hasan, there have been many cases of companies that are genuinely eager to meet analysts and talk about their business strategies.
Why, then, is research still so one-sided? One reason is that the relationship between analysts and management is still quite fragile, as many of the markets in the region have historically been dominated by retail investors. “Two years ago you would have gone to these companies and written research on them, and it wouldn’t have mattered a jot because it was a retail-driven market. The management knew that,” says EFG-Hermes’ Khoury.
Mena Capital’s Majeed says: “The brokers still don’t like saying ‘sell’ because they are afraid that it would hurt their relationship with the company they are doing research on.”
If research in the Middle East continues to be overwhelmingly positive, however, in some ways it is simply because stocks in the region have already taken a beating, and so are starting to look less overvalued. Market observers are beginning to think that a recovery is on its way, and that this time it will be more sustainable.
For many, the market correction, combined with the realization of many governments in the Middle East that they need to diversify away from oil-generated revenues, might be said to have triggered a benign circle. Good basic growth prospects and high oil prices are propelling more international interest in their markets, more institutional investors, and increasingly insightful research.
Global’s Hasan says: “With the opening of the economies, institutionalization and the coming of age of the research houses, it is now easier to get access to the management. This, together with competition from new local research houses and the arrival of foreign investment banks, means research is finally beginning to bloom.”
It is hardly surprising, then, that many people are now optimistic about the region’s prospects. Algebra Capital’s Kawkabani expresses a fairly common view among the Middle East’s fund managers when he says that the regional stock market downturn has almost reached its end.
Adia’s Zawaideh even believes that the timing of the Middle East’s recent woes might turn out to be beneficial to the region if stock markets elsewhere begin to decline and people start to search around for better-performing assets.
Yet the wild card lurking in all of this comes in the form of Saudi Arabia: not only the region’s biggest market, but also one that is the most closed to international investors, yet is retail-dominated and sentiment-driven. Research in Saudi Arabia, like the recovery of its stock market, is still lagging behind such countries as Qatar, UAE and Kuwait. Its government, concerned about the need to maintain strategic ownership of certain sectors, keeps the stock market off-limits to foreign institutional investors.
Saudi Arabia opens up
Nevertheless, even in Saudi Arabia the financial sector is opening up, and better research is beginning to creep in. Foreign residents are now allowed to invest in the stock market, and regulation has also improved. Some of the speculators who did so much damage before the pre-crash euphoria have been fined; companies whose losses have gone out of control have been forced to stop trading; leveraged retail investors have been reined in.
Institutionalization in the Saudi Arabian market is maturing. New investment banks are opening and, in the past few months, both EFG-Hermes and Global have been awarded brokerage licences in Saudi. For the moment, however, most of the new institutions are focusing on broking, corporate finance and M&A. Two new funds have opened in the past few months: Jadwa, with people who left Samba (Saudi’s biggest investment bank), and Ajeej, with two people from the investment arm of the Olayan Group (a Saudi Arabian multinational). Yet most banks are still staying away from investment management.
Mena Capital’s Majeed says that he is certain that these new institutions will eventually turn their hand to investment management. But the Saudi market will only be entered more actively by institutional investors, Majeed says, when international investors are allowed in: something he foresees, with the entry of Saudi Arabia into the World Trade Organization, happening sooner rather than later.
“Why would the Saudi authorities have licensed the likes of UBS, Deutsche Bank, Merrill Lynch and Goldman Sachs if they didn’t want them to bring in their foreign clients?” he asks. “What might happen is that they turn a blind eye to these banks providing access synthetically through swaps and derivatives.”
