Even as the market is in the grip of an Omantel effect, participants are looking forward to the third-quarter earnings season. BankMuscat Equity Research

The US markets eked out moderate gains as better than expected economic data failed to improve investor concerns over the deterioration in delinquency rates in the sub-prime mortgage market. The Dow Jones industrial average gained four per cent during the month while the Nasdaq advanced 6.8 per cent on the back of a larger-than-expected cut in interest rates (50 basis points versus an expected 25 basis points) which convinced investors that the Federal Reserve is prepared to do whatever is necessary to counter the subprime credit crunch and prevent a recession.

European equity markets also enjoyed a positive run due to positive contribution from stocks in the resources and other cyclical sectors, while the building-materials, airlines and UK banking sectors underperformed during the period with a strong euro beginning to have a detrimental effect on exports. Despite the uncertainty surrounding local politics, Japanese equity markets posted an impressive growth of 7.6 per cent. Liquidity seems to be shifting towards emerging markets and most of the emerging markets gained in September with the majority of this strong monthly performance coming from the larger markets like Brazil, China and India, which all posted double-digit returns.

Omantel effect

The Muscat Securities Market was the best performing market in the GCC last month. The index saw a dream run over the last four weeks gaining 12.5 per cent. Even on a year-to-date basis it has outperformed regional markets. The move was largely brought about by a substantial appreciation in OmantelÕs stock price. In fact, Omantel accounted for 55 per cent of the 833 points gain, implying that there are stocks still available at pre run-up valuations.

The government has set up a ministerial committee to improve OmantelÕs performance and rationalise its operations with the intention of improving shareholder value. The qualitative aspects of the proposed scheme include merging Oman Mobile and Omantel in addition to bringing in a strategic partner. On the quantitative side, which would reflect immediately, the government has decided to reduce the royalty that Omantel pays as a percentage of its revenue. At present Omantel pays ten per cent of wireline revenue and 12 per cent of wireless revenue. Both these figures have been reduced to seven per cent and will be applied from 2007. We expect major savings for the company to the tune of RO13-14mn starting this year or 16bz per share post tax. The same would be applicable to Nawras, the second mobile operator, in line with the spirit of the telecom law. We view the above developments as positive for the company, though we would like to blend these one-off positives with long-term concerns mentioned earlier in our updates. We continue to express concern on the possibility that OmantelÕs monopoly could end in international gateway or lowering of interconnection charges from Nawras to Omantel on international calls, if the telecom regulatory authority liberalises the sector further.

Potential winner

Among the small cap stocks we are bullish on is Gulf Mushroom (GM) following our recent company visit. The company has turned around and is reaping the twin benefits of favourable demand-supply situation and strong profit and loss impact of the strategies adopted in the recent past. We expect the company to wipe off its accumulated losses in 2008. Strict monitoring and better planning has improved crop yields three fold over the last four years, which is the key in the agriculture business. The realisations also improved due to a focus on fresh mushroom and a weaker dollar, which made imported mushroom expensive, offering the company an opportunity to increase prices and still ensure that its rates are cheaper than the landed price of imported mushrooms. The UAE, which accounts for 80 per cent of GMÕs sales, offered a ripe opportunity due to this factor and limited competition.

Going forward, near flat realisations and sticky raw material costs should maintain the improving trend in per tonne EBITDA as other cost coverage improves. However, the risks of fragile balance sheet even after the strong performance remains and it would take at least two years for the balance sheet to be reasonably healthy to support any dividend payouts. The company can clock a turnover of RO3.5-3.7mn on full capacity; small company risks and scalability issues are inherent to GM. Being in the agro-business, crop failures could prove to be a major set back. At the current price of 355bz, the stock trades at 8.1x and 5.3x FY07 and FY08 earnings, respectively.

What's in store

Going by technicals the market might look over bought in the context of a sharp run up, but we continue to be enthused by the corporate financial performance. In addition, with oil prices touching US$90 a barrel the momentum in government expenditure will be maintained. As we run into the quarterly earnings season any positive surprises, especially from the banking sector, could give a leg up to the market. The banking and investment index has underperformed the broad index moving up 7.4 per cent in the last four weeks compared to 12.5 per cent for the MSM index. The listing of Galfar Engineering shares in a strong market is further expected to buoy investor confidence. We continue to be comfortable with valuations despite the strong run up in the index. The BankMuscat universe of stocks that accounts for RO5.7bn of market capitalisation (85 per cent of total market cap) trades at 14.4x FY07 and close to 12.3x FY08 earnings. Therefore fundamentals suggest that the bull run should continue, though a correction is welcome at this juncture.