Milltrust SEDCO MENA Fund Banner - Archive

Yazan Abdeen, Portfolio Manager for the Milltrust SEDCO MENA (UCITS) Fund, and Lead Fund Manager at SEDCO Capital, shares his outlook for the MENA markets and the key reasons to be invested in the Middle East:

Key growth drivers.

  • Maturing Markets. The MENA region is in a state of transition towards becoming a distinctly identifiable subset of the emerging market universe, in a way similar to Latin America or Southeast Asia.  The region represents a growing investible universe driven by a strong IPO pipeline and the recent opening of the Saudi market to foreign investors and inclusion into the MSCI EM Index.
  • The Saudi market. Saudi Arabia has recently opened its stock market to foreigners in 2015, offering access to an important emerging market the size of Russia’s.  Its average volume is about $2.2 billion a day, making it more liquid than all the rest of the Middle East’s markets combined. MSCI is expected to include Saudi Arabia in its emerging-market index as early as 2017.  The MSCI Saudi Arabia index, which covers about 85% of the free float, has about two-thirds of its weight in financials and basic materials, while telecoms and consumer stocks account for close to 20%. In contrast, more than half of MSCI Russia is in energy, and about 80% of MSCI United Arab Emirates (UAE) is in financials.
  • MENA has some of the highest population growth rates in the world. By 2025, there will be an estimated half a billion people in the region, up from 355 million today.  Saudi Arabia has a population of nearly 30 million people, two-thirds are Saudi nationals and 50% are below the age of 25.
  • Attractive Valuations. The MENA markets offer reasonable valuations with US dollar-pegged high dividend yields.

MENA Valuations

  • Diversification: Globally & Within.

MENA Diversification

Key risk factors.

The potential downside in the coming 12 months can be triggered by momentum driven by the following scenarios:

  • The effect of oil: The Gulf economies collectively have run a current account surplus of more than 20% of GDP for six of the last ten years, with Saudi Arabia saving close to 25% of oil export revenues in the past decade.  Moreover, the size of foreign exchange assets will also determine how each economy can adjust to lower earnings by running down reserves to maintain spending, and how much confidence it retains from investors. Fitch calculates that Saudi has a relatively high break-even price of more than USD 90/barrel, but net sovereign asset holdings equal to 111% of GDP, the fourth largest for all credit-rated sovereigns, means it can absorb years of low oil prices without too much difficulty.  Abu Dhabi produces a lot of oil per capita and therefore has to devote less of its oil revenues to meeting its people’s needs; it has a low fiscal breakeven point of around USD 50-55 a barrel of crude and runs a fiscal surplus over 10% of GDP. Despite the lower oil prices, on a country level, Saudi which has accumulated substantial reserves and a low debt to GDP, has the fiscal power to continue spending despite lower oil prices; UAE and Qatar will continue to spend, driven by the impending deadline of the World Expo 2020 and the World Cup in 2022, respectively; meanwhile Egypt is expected to continue to benefit as a net importer of oil.



  • Escalation of the war in Yemen
  • Deadlock in the National Transformation Program in Saudi from an execution perspective
  • Regional geopolitical risks escalation can cause short term volatility before normalization


  • Saudi Arabia: National Transformation Program, It is all about efficiency

Saudi Arabia is much more dynamic nowadays. As oil prices dropped from more than $100 per barrel to less than $30 per barrel we’ve seen a lot of changes and much more are yet to come. The more dynamic counsel of economic and development affairs have been fine tuning a lot of the norms that we were used to in Saudi Arabia in the past. From reducing subsidies on energy to rationalizing government spending on projects in addition to an ambitious plan to privatize many of the government assets and companies and ending by finalizing a VAT proposal within the GCC and proposing sin taxes on tobaccos and sugary drinks. Saudi Arabia is defiantly not idle any more.

Saudi government understands the importance of maintaining strong spending which is reflective on 2016 budget that was SAR 20 billion less than last year’s budgeted expenditure representing only a 2.3% drop YoY. which shows government commitment toward the economy. Furthermore, the allocation priorities are still the same as the last few years with the highest spending allocation to the following sectors: Military and security services 25%, followed by education at 23% while health and social affairs came third at 13%.

However, the main theme change here is spending efficiency. Through a set of announced measures it seems clear that the government intends to curb current and capital spending. For example, gradual removal or reduction of subsidies over the coming 5 years which already started by hiking energy prices. Also, creating a National Project Management Agency with the goal of optimizing and prioritizing government capital spending. Also, the continuation of the e-government program to control growing number of government employees. Finally, setting a structure where ministers’ performance is to be judged against measurable and time framed KPIs.

In addition, the budget of 2016 has focused on reducing the government’s dependence on oil, Non-oil revenue is expected to increase by 37% this year, stressing the importance of generating more revenue from investments and other diversified activities. This fits the master plan to diversify the economy away from oil. Revenue restructuring initiatives to include:

  • Implementation of the VAT within 2 years
  • Sin Taxes on Tobacco and sugary drinks
  • Partial and full privatization to include state owned companies (announcement of ARAMCO 
  • Chartering schools and transforming the health care system to an insurance-based, privately 
provided health-care system.
  • White land tax at an annual rate of 2.5% 
The government has taken these steps as preemptive measures bearing in mind that the Saudi foreign reserves stand at USD 616 Billion and Saudi Arabia’s debt to GDP is at 5.8%.

The government revenue restructuring is nothing but a step in the process to transform the economy as part of the national transformation plan announced in late 2015. In addition to the revenue restructuring plan, the transformation plan aims to:

  • Solving the housing problem
  • Encouraging the private sector through removing all hurdles and barriers
  • Diversifying the whole economy away from oil and oil related industries
  • Encouraging local production and supporting non-oil exports
  • Encouraging innovation & knowledge economy
  • Expanding the scope of privatization

The Development of education and higher education. Given these facts, the Saudi government going forward would focus more on sectors such as mining, tourism and the industrial sector. The bill of diversifying the economy and developing these sectors will amount $4 Trillion as stated in the Mckinsey & Company report “Beyond Oil”. The government is not only banking on its ability to focus the spending into these areas but also seeking the partnership of the private sector which is going to be the main driver in the new transformed economy.

  • UAE: On the path to celebrating the last barrel of oil

With a relatively less dependence on oil revenues (70% of GDP is non-oil related) and the strong reserves compared to the other GCC countries, the UAE is better situated to withstand the depressed oil prices. Despite the slightly lower federal budget for 2016 (down 1%), Dubai’s ruler has approved a 12% increase in the emirate’s spending for 2016 to reach AED46.1bn. This is expected to keep the growth in the emirate in line with the planned levels of the government. Around 36% of this spending is set for infrastructure and transportation projects in preparation to host Expo 2020.

Moreover, the continued growth in tourist arrivals along with lifting the sanctions on Iran would support further growth in the UAE’s economy. As for the increase in tourists numbers, this should benefit companies that provide retail and hospitality services like Emaar, EMG and Air Arabia. Also, this could trickle down to other names that are not directly exposed to retail like the telecom companies and banks. Therefore, the growth in the UAE would mainly be supported by the tourism sector and the continued spending of the government.

On the other hand, lifting off the sanctions on Iran could be both positive and negative to the UAE depending on what sort of investments and trade would flow to Iran. Historically, the UAE has been one of the biggest trading partners to Iran with exports from Dubai to Iran reaching USD29bn in 2014 (around 13% of total exports from Dubai). Lifting the sanctions would drive more trade with Iran on a global scale which could benefit some companies the UAE while posing as a threat to others. For instance, companies that could potentially benefit are DP World and Aramex with both having well established global infrastructures that could support trade and transfer of goods between other nations and Iran. Again, Air Arabia could also benefit from this if they increase their flights from and to Iran. The other side of the token would be companies that will not benefit or could potentially be harmed by lifting off the sanctions. Those companies are the ones that had sizable trade (mainly exports) with Iran. Now without the sanctions, many other countries/companies would be interested to grow their business with Iran which would increase the competition faced by companies based in the UAE. Nevertheless, we believe that the bigger picture for the UAE seems to be brighter than most of its neighbors.

  • Egypt: The Challenges Remain

Macro headwinds still persist with the double deficit both on the current account & Fiscal levels reaching 4% and 12% GDP respectively. The FX reserve level still low due to low remittances and the now lower ability to gain form GCC aid due to lower oil prices. Energy still an issue that could be solved from a lower price for Egypt being a net importer but it will also halt all new exploration activities planned by the government to reach energy independence. Tourism revenues declined post the attack on the Russian aircraft and the decision to suspend all flights to Egypt by European countries, global trade slowdown also affected the Suez canal revenues despite the latest expansions.

On the monetary policy side, Central bank policies should still be tilted towards a weaker EGP but should also discourage imports through encouraging local substitutes by supporting SMEs that could cover the trade deficit. Egypt is still under the grip of inflation with high level imports and relatively a weaker currency.

Real estate was for the past year and still is the most attractive investment sector in the market with companies showing resilient earnings throughout 2015 from the expansions in property developments and planned master communities to cover the shortage of the 3.5M units. Companies in the sector are also joining forces to tackle larger size developments being pushed by the government through ministry of housing/finance alongside the New Urban Communities Authority. We favor MNHD and Palm Hills as the major players and low cost developers with sizable land bank, low development cost bases and an encouraging projects pipeline.

The inevitable growth in consumption powered by population and guidance on economic conditions improving in the near future also favor the staples sector namely Egypt’s leading dairy and juice producer, Juhayna which achieved 60% revenue growth YoY and an 800bp improvement in gross margins. The defensive spectrum of Healthcare, favors generic pharmaceuticals like EIPICO to continue to grow not only in Egypt but beyond borders providing investors with a dividend yield of 6-7% in the coming 2 years thanks to its debt free balance sheet.

  • Oman: Getting deeper in the mud

We have mentioned last year that Oman would face a tough year in 2015 and that story still carries on this year, only the situation seems to get somewhat tougher this year. The government has already announced that spending in 2016 will be cut by 16% to around OMR11.9bn (USD31bn). This was mainly done through cutting current spending and decreasing subsidies by two thirds. These two fundamental changes might create structural instability in a fragile economy.

Revenues are also expected to decrease this year, falling by 26% to OMR8.6bn (USD22bn) which will create a deficit of OMR3.3bn (13% of 2016 GDP). This deficit is less than the one recorded in 2015 (OMR4.5bn) but the main issue here is finding the sources to fund it. To fund the deficit of last year, the government used a mix of foreign assets reserves (53%) and borrowing from the local banks (47%). This year the situation is trickier, the local loans to deposits ratio is very high (above 100%) while the NFA reserves are down by USD3.2bn to USD12.3bn. Therefore, it would be very difficult for the government to borrow from the local banks while withdrawing from the reserves would put more pressure on its savings. Therefore, it seems that the government would seek funding from foreign creditors. Moreover, the council of ministers has approved increasing the corporate tax rate from 12% to 15%.

So what does all this mean for the market? Well, the one thing for sure here is that it would be a tough year and we believe this is shown in the cheap valuations of the market. The Omani market is trading at a trailing P/E of 9x which is at an 18% discount to its 5 year average of 11x. There could be a few opportunities to pick but as the whole market we believe should be underweighted this year especially with the relatively better prospects of other markets.

Forecasted return for each investment over the next 12 months (in USD). 

  • Rather than giving an absolute target return for each stock in our portfolio for the coming 12 months, we can provide our internal valuation upside to downside ratio (the best case scenario of the business projection divided by the worst case scenario business projection in terms of valuation) and we come to a blended 1.35x multiple for the portfolio, implying that we are expecting 1.35 units of return for every unit of business risk that we are taking.
  • For the next 12 months, we believe that the major catalysts that could provide significant upside to the markets are:
  • The Yemen war stopping – catalyst for Saudi, UAE and Kuwait
  • MSCI consultation for Saudi market inclusion into MSCI emerging markets indices – catalyst for Saudi
  • Expedited construction to provide housing in Saudi – catalyst for Saudi and UAE
  • Possible GCC-Iranian conflict resolution – catalyst for UAE and Qatar
  • Oil price rising above $60 – catalyst for GCC and Egypt
  • Egyptian pound further devaluation – catalyst for Egypt

Potential downside over the next 12 months (in USD).

The list of potential downside triggers in the coming 12 months has been mentioned above across 4 points:

  • Escalation of the war in Yemen
  • Dropping oil prices by more than 50%
  • Deadlock in the National Transformation Program in Saudi from an execution perspective
  • Regional geopolitical risks escalation can cause short term volatility before normalization

When all these 4 points were stressed in January of 2016 all at once, markets were trading 16% lower than where they are now.

June 2016