Global Finance’s first annual ranking of the top-performing companies in the Middle East shows how much of the region is still in the early stages of reducing its dependence on oil.
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Saudi Arabia remains highly dependent on oil, but many of its non-energy-related companies are likely to draw interest from outside the country when it opens its stock market to foreign investors, an event that could take place as early as this month. Fifteen of the 25 top-performing companies in the region are Saudi, and most of these are only indirectly related to energy, according to an analysis by Global Finance.
In fact, the ranking—which is based on an unweighted average of the return on assets, profit margins, solvency and market valuation of the 250 largest public companies in the region by market capitalization—illustrates the degree to which Saudi Arabia has diversified its economy, a process analysts say is critical for the country, given the recent decline in oil prices.
Four of the five best-performing companies, for example, are not only Saudi but also operate in the non-energy petrochemicals and construction industries. The number-two company in the ranking, Saudi Arabian Fertilizer Company, or Safco, for instance, produces ammonia, urea, sulfuric acid and melamine and uses them to manufacture fertilizers. The number-three company, Makkah Construction and Development, is helping expand the city of Mecca. The fourth and fifth companies, Qassim Cement and City Cement, as their names suggest, manufacture and sell cement.
None of this suggests that the Saudi economy is no longer heavily tied to supply-and-demand trends for energy. According to a report last month by Fitch Ratings analysts Paul Gamble and Richard Fox, oil still accounts for 90% of the country’s fiscal revenues, 80% of current-account revenues and 40% of GDP. And as Gamble and Fox wrote, “spending of oil revenues is a key driver of the non-oil economy.”
In an interview, Gamble, director, sovereign group at Fitch, pointed out that it’s difficult to compare the performance of non-oil-related Saudi companies with those connected to the industry because, except for petrochemicals, the latter aren’t publicly traded. And the growth of many ancillary industries, and those involved in construction in particular, are “a direct result of the energy endowment.”
In any case, the Saudi government has a plan in place to spend $130 billion to boost non-energy industries (over an unspecified period), and Schroders recently estimated that opening its stock market to foreign investors could lure as much as $40 billion of that from abroad. (Makkah and other companies working on holy sites, however, won’t be open to foreign investment.)
Diversification comes none too soon, according to Gamble and Fox. Though the analysts affirmed Fitch’s AA credit rating on Saudi Arabia, they noted that unemployment among nationals and a shortage of affordable housing are “potential economic sources of social discontent.”
Non-oil private sectors are growing at a much faster rate than they did in the past, averaging 7.2% for the past five years and outpacing oil sector growth for 10 of the past 11 years. But non-oil sectors saw their growth rate slow to 5.7% last year. And although Fitch expects a bonus to public-sector workers to lift consumer spending in 2015, the analysts warned that “potential cutbacks in spending beyond those currently forecast will test the strength of the private sector.”
Gamble notes that much of the private sector’s strength is still tied to government spending, and points out that the magnitude of the decline in oil prices raises questions about the Saudis’ ability to step up spending, as they have done during smaller price dips in the past. “It will be interesting to see how they respond this time,” he says, adding that “you are seeing diversification. The question is what happens when the government cuts back [on spending].” He says that question also applies to other Gulf countries.
Fitch isn’t alone in raising such alarms. Standard & Poor’s downgraded its outlook for Saudi Arabia from “positive” to “stable” in February because of the sharp decline in oil prices and said its concerns extended to much of the rest of the Gulf Cooperation Council. S&P analysts Trevor Cullinan and Remy Carasse observe that “due to Saudi Arabia’s high dependence on the commodity [oil], we think that the sovereign’s very strong fiscal position could weaken.” S&P earlier downgraded its ratings of Bahrain and Oman after oil prices fell 50% from their level in June of last year.
A report for the first quarter of 2015 by Capital Economics, a London-based research firm, offers a similar outlook for the region. “Fears of steep falls in output in the Gulf are overdone,” the report stipulates, but predicts that “growth will weaken in the coming years.” The firm projects Saudi GDP to advance by only 1.5% to 2% this year and next, which it notes is “by no means a disaster,” but which is also far less than the 5% to 6% growth seen during the previous decade. That scenario suggests Saudi companies could have a hard time repeating their performance in next year’s Global Finance ranking.
This year’s results also reflect efforts by other countries in the Gulf to lessen their dependence on oil. The seventh-best-performing company is Qatar National Cement, while number 14 is Bahrain Cinema. And the 21st- and 22nd-best performers are Gulf Hotel Group of Bahrain and Qatar Industrial Manufacturing.
An analysis of individual corporate sectors in the Middle East shows similar results, with companies from Saudi Arabia and other nations in the Gulf dominating the ranks of best performers in eight sectors out of 11—that is, in all but pharmaceuticals; technology, telecom and media; and energy, where the study finds that Israeli companies outperform. (That country’s companies also account for six of the top 25 overall.)
Saudi luxury goods maker Fitaihi Holding Group, for example, comes first among consumer products companies in the region. Its fourth-quarter earnings rose 24% from the same period the previous year, to SAR44.4 million ($11.8 million) from SAR35.7 million in Q4 2013.
Four out of the top five food, beverage and tobacco companies in the region are Saudi, with Herfy Food Services ranking first. Herfy, which operates and franchises restaurants primarily in the kingdom, saw its net income fall 5% in the fourth quarter of last year, to SAR48.7 million from SAR51.3 million, but margins remained well above 20%, and the company plans to build 30 new restaurants this year.
Saudi-based Dallah Healthcare leads the services sector, trading at 44 times trailing 12-month earnings, though they were flat during the last quarter of 2014 compared with a year earlier at about SAR50.4 million, as the company sports profit margins north of 20%. Two other Saudi healthcare companies, Mouwasat Medical Services and National Medical Care Co, place second and third in the sector. Mouwasat, which runs hospitals, clinics and pharmacies in the kingdom, saw its net income advance less than 1% in the fourth quarter of last year, to SAR50.7 million from SAR50.4 million for the same period the previous year, but analysts predict they’ll rebound by 16% this year. National Medicare Care, which also operates hospitals in Saudi Arabia, reported a 52% drop in net income in last year’s fourth quarter, to SAR9.8 million from SAR20.4 million for the same period in 2013, but analysts expect them to bounce back by 25% in 2015.
In transportation, Saudi Airlines Catering ranks first, just ahead of Kuwait’s KGL Logistics. Analysts estimate that the Saudi catering company’s earnings will grow 10% this year to SAR 8.8 million, as margins exceed 30%.
Meanwhile, one company that ranked sixth in its sector and 106th overall in the Global Finance study, Emaar Properties of Dubai, recently won a vote of confidence from Moody’s Investors Service. In reference to Moody’s upgrade of the company from stable to positive, analyst Rehan Akbar cited “the strengthening of Emaar’s real estate development, hospitality and retail operations and its disciplined approach to capital expenditure during the recent market up-cycle, which, together with the firm’s solid liquidity position and sizable property sales backlog, will insulate the company against an anticipated moderate price correction in the Dubai real estate market.”
Emaar is also a favorite of asset managers such as José Gerardo Morales, chief investment officer of Seoul-based Mirae Asset Global Investments (USA). Morales told Global Finance that Emaar was one of the few Middle Eastern companies he held at present because of his concerns about regional political stability.
But the big concern remains the impact of declining oil prices. Oil importers in the Middle East/North Africa (MENA) region will benefit from the price decline, of course. The International Monetary Fund forecasts that regional oil importers, including Afghanistan, Djibouti, Egypt, Jordan, Lebanon, Mauritania, Morocco, Pakistan, Somalia, Sudan, Syria and Tunisia, will see GDP grow by an average of 3.9% this year, 40 basis points more than the IMF predicts for the global economy overall.
Jason Tuvey, Middle East economist for Capital Economics, believes that Egypt and Tunisia are well positioned to benefit from such development efforts after six years of political turmoil. More broadly, Tuvey points out that manufacturing is the most sustainable means of growth for emerging economies, thanks to potential productivity improvements that can lead to wage gains and, in turn, higher living standards. He cites Asia as the classic example of that development model.
In contrast, Tuvey sees less potential for development in the Gulf economies. Even Dubai, which he acknowledges as “a success story,” has in his view merely transformed itself into a logistics and finance hub for the Gulf, which means it is still ultimately dependent on the oil industry. Diversification in this part of the Middle East, he says, “is still a long way off.”
For that reason, the IMF expects GDP growth of only 3.4% for GCC countries that export oil—and a full percentage point less for non-GCC exporters, including Algeria, Iran, Iraq, Libya and Yemen.
In fact, the IMF cautions that the oil price decline coupled with a slowdown in global growth presents the Middle East with both “an opportunity and impetus to reform energy subsidies and step up structural reform efforts to support jobs and growth.”
In sum, parts of the region have made great strides to turn the private sector into a productive source of growth, as reflected in our rankings of top-performing companies. But even those countries have a long way still to go.
As for the rest of the region, with a few exceptions, they lag even further behind. Few oil importers in the region or non-GCC exporters are represented in this year’s rankings. A key question is how these two groups will respond to the decline in oil prices and global demand. If the answer is “dramatically,” next year’s rankings could look very different.
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