Dubai: The recent anti-corruption drive may dampen near-term market sentiment but is likely to provide further impetus to ensuring success of reforms and gains in Saudi stock valuations, according to Bank of America Merrill Lynch (BofA Merrill Lynch).
“We retain our positive view on the Saudi market given attractive valuation, with the Saudi market now trading in line with global emerging market compared to a historic premium of more than 20 per cent and improving fundamentals, with earnings upgrades outpacing downgrades and a more robust oil backdrop,” said Hootan Yazhari, research analyst, Merrill Lynch, DIFC.
Other positives for the market include the prospect for accelerating growth in the non-oil economy coming on the back of reform programs; the potential for a slower pace of austerity reforms than previously thought as well as clear lines of support for leading local companies (National Champions) and the approaching potential inclusion of Saudi market in MSIC Emerging Market index and FTSE Emerging Market index in 2018.
Analysts expect the market to face short term challenges. “Given the emergence of a number of risks, we believe appetite for the Saudi market could be tempered in the near-term. These include heightened geopolitical risks and lack of clarity on the pace of reform. As such, we view it unlikely the market will outperform peers till greater comfort is obtained on these issues, which we see emerging towards the end of the year when the 2018 budget is presented,” said Yazhari.
Improving earnings expectations
The Saudi market has underperformed emerging market peers by about 34 per cent year to date and 18 per cent since early July. This comes despite improving earnings expectations and a more healthy oil back drop.
This underperformance has left the market trading at 13 times 12-month forward P/E, in line with emerging market peers, 15 per cent below long term average levels.
“The Saudi market has historically commanded a more than 20 per cent premium to emerging markets on average, indicating that a relatively cautious outlook is being now discounted, including minimal amounts for the rapidly approaching twin index events of 2018 as well as underlying reforms,” said Yazhari.
Geopolitical risks
The recent arrest of Saudi Princes, sitting ministers, former ministers and businessmen on corruption charges has caused uncertainty and unease in the Saudi market. Whilst BofA Merrill Lynch analyst see the action as an effective way of tackling corruption, the prospect of further arrests and charges could temper appetite for Saudi equities in the near-term. Elsewhere, concerns over escalating risks between Saudi Arabia and Iran present further uncertainties that could also weigh on sentiment in the region. As such, until more clarity is obtained on these issues, we see little scope for major re-rating near-term.
