JEDDAH – With the end of the Ramadan season and approaching winter, the volume of Saudi stocks would pick up in the next few months, Al Rajhi Capital said in its recent report on Saudi stock market. TASI has relatively underperformed its global peers over the past three months (TASI's +5.8 percent versus +6.9 percent for MSCI world), mainly due to a decline in crude prices and under-performance of its major sectors – petrochemicals and banking. Given that the Saudi economy is driven by oil and petrochemicals exports, TASI's movement is implied to be correlated with the movement in Brent crude prices. This trend has held true in the past except for 2011, when the correlation between the market and Brent price movements was surprisingly negative. Al Rajhi attributes this negative correlation to the Arab uprisings in the MENA region. Some of these disturbances spilled over to Saudi Arabia, resulting in a sharp decline of TASI in February and March 2011 by more than 20 percent, while they led to a surge in crude prices on concerns about supply disruptions. Although the correlation between TASI and Brent price movements has become positive since the beginning of 2012, the report noted that it remains subdued in comparison with correlation with a benchmark index like MSCI World. “We consider this a positive trend and as an indicator that the Saudi market has become mature and more stable, also taking into account the fact that much of the upside to crude prices was on account of the quantitative easing policies undertaken by the governments in the US, Europe and China rather than actual demand. Moreover, the retail investor participation, which accounts for bulk of the trades carried out on Tadawul, has remained strong despite the volatility seen in the Saudi market this year. Traded volumes by retail investors increased by 90.5 percent y-o-y during the month of August to 3.8 billion. This continued strong participation by retail investors is a positive signal for the Saudi market. Net purchases through swap agreement stood at SR171.3 million in August. Since foreign investors can enter the Saudi market only through this route, Al Rajhi consider this as a positive driver for the market. Average trading activity through swaps reached 0.75 percent in August, compared to 0.40 percent in March 2012. Although the trends mentioned are disparate, all of them point toward the Saudi market becoming more mature and acquiring depth, which bodes well for the market as well as for investors over the long-term, the report said. In 2012, the Saudi market has made a marginal positive return during the holy month. For the rest of the year, Al Rajhi believes TASI will end up moderately higher from the current levels. In addition, the positive correlation between volumes and returns also indicates toward a positive return on TASI. “We expect trading activity to pick up in the winter season between the months of September to December, similar to the trend witnessed in 2011." The 2012 P/E multiple for TASI is higher than many of the GCC markets, which is justified by the higher economic growth potential of the Kingdom, the report said. TASI currently trades at a P/E multiple of 12.4x, which is at a marginal premium to major markets across the GCC region. Compared to international indices, the Saudi market looks fairly valued, trading at a discount to developed markets like US and Japan, and emerging markets like India, but at the same time trading at a premium to Brazil and Hong Kong. Sector-wise breakup of the market indicates that the P/E multiple for two major sectors in TASI — petrochemicals and telecom — remains low, compared to global peers, suggesting a possibility of further upside. However, the banking sector, another major component of TASI, is trading at a premium on a forward P/E basis as compared to other regions, even though the sector has witnessed improved profitability in Q2 2012. “We believe that the higher P/E ratio is justified as the Saudi banking sector continues to be strong and post solid results, which indicates that the sector is well protected from the global turmoil. We believe that there is still an upside potential for the banking sector even considering the valuation premium," Al Rajhi report said. Analyzing TASI and trading volume movements since 2007, a positive correlation between the trading turnover and TASI's performance is noted. Most recently, this trend was witnessed in the first quarter of 2012, when trading volumes rose sharply and TASI crossed above the 7,900 level. This was followed by an equally sharp fall in trading volumes and a correction in TASI during the second quarter. With retail participation in the speculation activity slowing down, the market is seen to gradually return to its fundamentals. Despite lower earnings expectations from major companies (especially petrochemicals), the Saudi market remains buoyant on the back of strong oil prices and increased liquidity. The high volumes witnessed during the year will continue to support TASI at higher levels, assuming there is no major negative geopolitical or economic news flow. The Saudi market is likely to move higher after Ramadan, on the back of high trading volumes (continuing the historical trend). However, trading volumes would stabilize over the next couple of quarters leading to a consolidation before the market moves upward, the report added. Telecom, agriculture, and retail sectors will outperform the broader market, it said. Agriculture and real estate sectors - which are driven by domestic demand - are expected to outperform over the medium term, while the export oriented sectors are likely to face headwinds. Crude prices were seen to be range bound near the current levels over the next 2-3 quarters. Moreover, a definitive solution to the eurozone crisis is not expected over the near term and the eurozone will continue to hamper the global recovery. On the issue of the Saudi market opening up to foreign investors, managers have a consensus feel it would take at least one to two years to materialize, the report added. – SG/QJM
