Markaz: 2008 to be a positive year for Kuwait stocks with return potential of 30%

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Markaz: 2008 to be a positive year for Kuwait stocks with return potential of 30% 02 - Jan - 2008

Kuwait Financial Centre "Markaz" in its latest research report expects 2008 to be a positive year for Kuwait stocks. The target index level for 2008 is 16310, nearly 30% above the current level. “At the heart of our call is the forecast for earnings. We expect earnings to grow by 42% during 2008. This is on the back of 63% growth in earnings realized during 2007” observes M.R. Raghu, Head of Research and Amrith M, Research Analyst. This earnings growth was in spite of muted earnings performance by Zain (MTC) which posted only 3% growth in earnings. However, other blue chips posted strong earnings like Kuwait Finance House (+46%), National Industries Group (+105%), & Gulf Bank (+32%). Year 2008 is expected to see Zain post a growth of around 40%. P/E: The price to earnings multiple for Kuwait jumped from a modest 11.7 in 2006 to nearly 20 by the end of 2007 thus breaching its long-term sustainable average of 18.3. A reversion to mean will imply a P/E contraction of about 8%. Stock Outlook: Some of the blue chips seem to have overrun in terms of their valuation potential relative to historical norms. Among the 5 largest companies, only two provide positive upside. Fund managers will have to dive deep into mid caps and small caps to unearth value in 2008. 2007: Eventful year During 2007 Kuwait stock market witnessed activity in terms of new listings. There were nearly 10 new companies that got added to the market during the year. Major announcements during the tail end of the year included slashing of capital gains tax for foreign companies from 55% to 15%. The de pegging of Kuwaiti dinar from US dollar during May 2007 constituted another major event during the year with subsequent revaluation. Kuwait telecom companies were seen aggressively vying for other state licenses as well as the foray of Kuwait Finance House in Malaysia. The year was also marked by various rumors on the possible mergers and acquisitions among Kuwaiti banks which induced considerable volatility. The stock market was also abuzz with merger and acquisitions activity with transaction value of more than $3 billion dollar. More than 30 transactions were noticed wherein Kuwaiti companies were actively pursuing acquisition opportunities both within Kuwait and outside. Most of the transaction appears to be small with two notable exceptions: NBK’s acquisition of National Bank of Egypt and Investment Dar’s acquisition (through a consortium) of Aston Martin. Agility’s foray into Kenya is also note worthy. The year was also notable in terms of investment companies and banks launching several equity and money market funds. Companies were also actively raising capital and debt in terms of Sukuks and rights issues. Notable among this is the establishment of an investment bank in Bahrain by Investment Dar with a capital of $1 billion. The Kuwait price index returned 25% for the year 2007, which compares favorably over the long-term average of 20% and also the negative return of 12% in 2006. There were sharp differences among sectors with the heavy weight banking sector posting a healthy 44% with investment sector not far behind at 28%. Food sector was the top performer with a return of 60% even though it is constrained by its size. Services and insurance were laggards. The reasonably good performance of the market has been backed by strong liquidity with volume traded increasing by a healthy 88%. Investment sector dominated the volume with a share of 34% followed by real estate at 28%. While banking sector constituted nearly 22% of total volume traded in 2001, it now accounts only for 7%. Backed by strong growth in volume, value traded also more than doubled during 2007. Services sector was the dominant sector with a share of 30% followed by investment sector at 27%. Valuation trended towards “concern zone” by the end of 2007 with historical P/E ratio touching 19.22 from a low of 11.7 witnessed during the end of 2006. While this represents a sharp rise, it is not way above the long-term trend average of 18.3. Blue Chip Action Zain: Zain witnessed a 75% appreciation in its stock price during 2007. This was not supported by growth in earnings of the company. The 2007 annualized net income growth is 3%. The stock price was predominantly driven by event related news flows. The company had acquired a license to operate in Iraq, acquired 75% stake in Western telesystems for USD 120 Mn and also acquired 100% of Iraqna Company. The increase in capital expenditure had dampened the growth in the bottom line of the company. The stock is currently quoting at a premium to most of its peers. The analyst’s consensus estimates for 2008 points out to an earnings growth of 37%. However, the stock is trading close to its peak valuations of 25x witnessed in 2005. We expect the PE to contract by 18%, however, the robust growth projections for 2008, provides a fair value estimate of KWD 4.32 implying a target rate of return of 13%. Kuwait Finance House (KFIN): KFIN recorded a 69% appreciation in its stock price during 2007. This increase in stock price was supported by 46% YoY growth in the bank’s annualized 2007 earnings. The stock price was driven by the bank’s spectacular performance and event related news flows. For the year 2006, the company’s Board of Directors recommended 57% cash dividend and 15% bonus share from it’s paid up capital. KFIN announced its plans to set up a KWD 100 Mn company to develop financial instruments compliant with Islamic Sharia. The bank intends to acquire 35 branches of RHB Bank, which is fourth largest lender in Malaysia. KFIN has received approval from Malaysian central bank .Furthermore, the bank announced its intentions to expand its footprint to Europe and Asia. The bank announced a 22.8% YoY increase in its net profit for the third quarter of 2007. We expect an earnings growth of 36% for 2008. At a current P/E of 30x, the bank is trading much higher than its six year average P/E of 21x. We expect the PE to contract by 32%. We estimate the fair value of the stock to be at KWD 2.62 representing, a decline of 7% from current levels. National Bank of Kuwait (NBK): NBK recorded a 2% decline in its stock price during 2007. The bank is expected to record a YoY growth of 16% in its annualized 2007 earnings. NBK acquired 51% interest in Al Watany, an Egypt based bank for USD 522 Mn in August 2007. NBK expressed its desire to expand its business in Saudi Arabia. In July 2007, the bank agreed to acquire 40% stake in Istanbul-based Turkish Bank. In order to fund these acquisitions, the bank has announced a rights issue to raise KWD 410 Mn. NBK received license from Bahrain’s central bank to establish NBK Investment Services in Bahrain. NBK launched its first brokerage trading hall in November 2007. This is likely to help the bank to provide real-time trading platform to its clients especially private banking clients. The analysts’ consensus estimate for 2008 point out to an earnings growth of 8%. At the current P/E of 19x, the bank is trading higher than its six year average P/E of 16x. We expect the PE to contract by 15%. Furthermore, the moderate growth projections for 2008, provides a fair value estimate of KWD1.86, a decline of 8% from current level. National Industries Group (NIG): NIG recorded a 43% appreciation in its stock price during 2007. The company is expected to record a YoY growth of 105% in its annualized 2007 earnings after a YoY decline of 29% in 2006 annual earnings. On 21 November 2007, NIG announced that the Board of Directors has approved its plans to increase share capital by 25%. The company plans to issue shares at a premium of KWD 0.8 per share. NIG acquired a 20% stake in Middle East Complex for Engineering, Electronics and Heavy Industries (MECE) for KD16 Mn in August 2007. NIG’s Board of Directors recommended 70% cash dividend and 10% bonus shares for the fiscal year 2006. The Board of Directors has announced USD 1.5 Bn Sukuk issue. We expect the company to report a 52% growth for 2008. At a current P/E of 14x, the company’s stock is trading higher than its six year average P/E of 11x. However, the stock is trading much lower than its 2005 P/E of 26x. Backed by significant growth in earnings, we expect the PE to contract by 19%. The growth projections for 2008, provides a fair value estimate of KWD2.06, an increase of 24% from current level. Gulf Bank: Gulf Bank recorded a 15% appreciation in its stock price during 2007. The Bank is expected to record a YoY growth of 32% in its annualized 2007 earnings. On 08 November 2007, the Bank announced that it has acted as a Mandated Lead Arranger to SABIC Innovative Plastics Holdings’ USD 5.4 Bn syndicated loan. Central Bank of Kuwait has approved the bank’s share repurchase plan on 11 September 2007. The bank intends to repurchase 10% of its shares within six months. In June 2007, Gulf Bank launched an online trading platform for shares listed on Kuwait Stock Exchange. The analysts’ consensus estimate for 2008 point out to an earnings growth of 8%. At a current P/E of 18x, the company’s stock is trading higher than its six year average P/E of 15x. We expect the PE to contract by 12%. The stock appears overvalued at current level. The growth projections for 2008, provides a fair value estimate of KWD1.64, a decrease of 6% from current level. Kuwait Economy: On a Strong Footing Economic Growth Kuwait is expected to post another strong year of growth in 2008, thanks to non-oil segment of GDP. Nominal GDP is expected to increase by 6% to $116 billion mainly on the back of growth in non-oil GDP. Oil GDP growth is expected to be mute at just 2.4%, in line with similar levels witnessed in 2006. This is due to expectation that oil price may not spike too high from the current high levels. The days of extraordinary growth may be over. For eg., nominal GDP grew by an average of 27% p.a. between 2003 and 2006. Fiscal Situation The year 2008 will mark yet another year of strong fiscal surplus with revenues outgrowing expenditure significantly. Revenues are projected to increase by nearly 10% while expenditure will increase by 15%. However, government projections continue to be very conservative with a projected deficit of $13.3 billion. This is due to the budget revenues being projected with an oil price assumption of $36/barrel for Kuwait crude. Current Account Kuwait’s current account surplus will be equivalent to 50% of its GDP, a far cry from 11% in 2002. However, the growth in surplus will be 6%. Positive trade balance, primarily due to burgeoning oil exports, will drive the current account surplus apart from other income and transfers. While exports are expected to grow by a modest 4%, imports may average a higher growth at 9%. Invisibles continue to record strong growth primarily due to investment income receipts earned from the portfolio of foreign assets managed by sovereign wealth funds. Inflation Inflation has started to raise its ugly head with the latest data pointing to a 4% inflation as of Q-2 2007. Kuwait has traditionally had very low rates of inflation. The average annual consumer price index increase for the period 2000-2004 was only 1.4%. Hence, the current level indicates a near 3 fold increase in inflation. The primary driver of this is the global food price rise with weaker exchange rate (until recently). The inflation is also due to strong domestic demand growth and shortage of certain goods. Inflation is forecaster to remain at the current high levels for 2008. Currency The Central Bank of Kuwait, in response to imported inflation snapped its currency peg to the dollar in May 2007. Prior to this, the dinar was revalued by 1% in May 2006. Subsequent to the de-peg, the dinar was again revalued by 2% by end July 2007. The extent of revaluation was not enough to reign in inflation. As of 25th December 2007, the Kuwaiti dinar was trading at 0.274/dollar, a 5% appreciation from the earlier level of 0.288/dollar that prevailed at the start of 2007. Interest Rates The monetary policy of CBK was closely tied to US monetary policy due to erstwhile peg to the dollar. However, post-depegging this was not to be the case. This enabled the spread between Kuwait discount rate and Fed rate to fall considerably from a high of 225 basis points to 75 basis points. However, the spread has since then increased as US began decreasing interest rate. ### About Markaz Kuwait Financial Centre S.A.K. 'Markaz', with total assets under management of over KD1.4 billion as of September 30, 2007, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was awarded a BBB+ corporate rating by Capital Intelligence Ltd.