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DP World : Room to lever up in GCC bond market

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12/04/2016 | 05:22pm CET

The GCC’s sovereigns and corporates have, for some time, come under increasing pressure from credit ratings agencies. This pressure is set to grow as debt obligations in the region increase. As that process develops, it will be new bond issuances that enhance diversity in the region, improve liquidity and lead to a broadening of the Middle East’s fixed income investor base. Findings by Fisch Asset Management’s subsidiary, Independent Credit View (I-CV), whose services are commissioned by investors as opposed to issuers, have clearly indicated that corporate governance in the Middle East needs to improve, particularly in regard to transparency surrounding the use of proceeds. This improved transparency will, in turn, require improved dialogue between issuers and investors. So, where is the region now, and where is it heading?

There is no doubt that Middle East countries have the capacity to lever up. The region has the highest average ratings globally, but budget deficits need to be addressed through a combination of investment and reform. The funding of these deficits can be achieved at a sovereign level or among government related entities. Privatisation will also play a key role. This is an exciting time for the region’s markets and the current scenario offers plenty of interesting opportunities for investors. Corporate governance still has room for improvement, and this will have an impact on pricing power–open dialogue with investors will positively affect credit assessments for issuers.

We recently reviewed Emirates Airline, who I-CV rated at BBB-/Marketweight for the issuance of senior unsecured debt. The report highlighted Emirates’ longstanding track record in successful airline operations as a strength, as well as Dubai’s ideal operational and regulatory environment. Key weaknesses included geopolitical and economic risks, along with oil price erosion. Although the market prices the 4.5 per cent Emirates Airlines 2025 issue with a risk premium of 230 basis points over Treasury (and this is in line with BBB Emerging Market Corporate Credits), we do not see much relative value, and we are therefore not currently invested.

Other leading GCC issuers are also under scrutiny. Saudi Telecom Company (STC), for example, was recently rated at A- by I-CV. Assessment highlights included its high and stable margins, free cash flow, pursuit of a regional expansion strategy, and the stability that is provided by state ownership. While the current low oil prices that have battered the Saudi economy do not seem to have impacted STC, that situation could change very rapidly. It has also been noted that up to 20 per cent of outstanding receivables could be classified as doubtful debts, which is a significant concern for any investor.

In March, Moody’s Investors Service said, unsurprisingly, that lower oil prices would slow growth and increase budget deficits in GCC countries in 2016. Last August, an I-CV credit analysis for Dubai’s DP World rated the port owner and operator at BBB (Marketweight), noting that despite its efforts to diversify it remained dependent on the UAE’s economic development. With the UAE’s economic growth expected to slow as a result of low oil prices, the proximity of companies such as DP World to unstable geopolitical regions in the Middle East presents commercial risk.

Such commercial risk is not carried by corporates alone, but by sovereigns too. I-CV’s latest review for Kuwait rated the country at A. Kuwait is endowed with abundant natural resources, large oil reserves and high per capita income, as well as a relatively robust fiscal position, a well-endowed sovereign wealth fund and large foreign currency reserves. However, important and glaring weaknesses have impacted Kuwait’s credit rating. These are, namely, limited economic diversification and dim growth prospects due to the oil price collapse. Oil is responsible for 90 per cent of Kuwait government revenues, and the country operates a generous welfare state largely financed by oil income. Diversification should now be regarded as a necessity, not a luxury.

But should we be comparing the GCC region with Latin America? Argentina’s recent experience, for example, suggests that there are obvious opportunities for GCC economies to exploit the sovereign debt market. Latin America’s third largest economy has just sold $16.5 billion of sovereign debt in its first international bond issue since defaulting in 2002. The deal’s underwriters received nearly $70 billion in orders for the bonds. This ‘emergency’ bond was issued by a government in a far worse fiscal position than any country in the GCC, and on top of a poor track record for defaulting, yet the issuance was four times oversubscribed. GCC countries still sit on large cash and oil reserves, and carry a relatively low default risk. Investor confidence in the Middle East as a growth market is still fairly robust, while transparency and governance at both corporate and sovereign level are showing signs of improvement. In short, GCC bonds remain an appealing prospect, particularly when we consider the recent success of prominent Latin American issuances.

We’re currently expecting increasing leverage across the GCC at a sovereign, corporate and household level. This will result in further downgrades throughout the region and, probably, higher risk premiums. On the other hand, the starting point for GCC credits is fairly comfortable, and investors can be expected to absorb the first wave of issuances relatively easily. The GCC will increase its weighting on various indices and more global investors will look at the region. Ultimately, this will bring improved liquidity in the secondary market.

With room to lever up, there are clear opportunities for investment and reform at GCC sovereign level. Demand for capital can readily be met by the issuance of sovereign debt, as well as by government-related entities. Another obvious way to attract capital is to divest a portion of the vast number of government-owned businesses across the GCC. The main threats to this process are misallocation of capital, coupled with domestic hesitancy and external doubts over fiscal policy reform.

We expect a number of sovereigns, such as Oman, Qatar and Saudi Arabia to issue in different tenors. This will give a clearer indication of risk appetite for bank and corporate issuance thereafter. Our view is that risk premiums will maintain their elevated position for the time being.

The UAE is perceived as a safe haven in the region that encourages investors and wealthy individuals to relocate their wealth and themselves to the country.” – Bruno Daher, CEO of Credit Suisse Middle East

(c) 2016 CPI Financial. All rights reserved. 2016 CPI Financial. All rights reserved. Provided by SyndiGate Media Inc. (Syndigate.info)., source Middle East & North African Newspapers

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