A strong start beckons MSM

As the economy continues to charge ahead, so will the bull run on MSM in the new year. Analysis by BankMuscat Equity Research

The global equity markets were hit by renewed concerns about the impact of credit markets on the wider financial markets, amid tightening liquidity and mixed economic trends. Treasury yields continued to ease on expected softening of interest rates in developed economies, with the US ten-year yields moving below the four per cent mark, while LIBOR rates moved higher on mortgage-bond and write-down concerns. Oil prices were in the limelight as they threatened to break the US$100 barrel mark, before profit-booking set in on concerns about the global economy. The US Fed announced its decision to cut the Fed funds rate by 25bps (it stands at 4.25 per cent) to buffer an anticipated slowdown in the economy, one that will be exacerbated by an expected intensification of the housing correction. The European economies are also expected to slow down as they absorb
currency strength, record oil prices, lower consumer confidence and credit market concerns. The Japanese economy grew at an annualised 2.6 per cent in the third quarter amid a fall in residential investment, strengthening currency and lower consumer confidence. The emerging equity markets outperformed developed markets on the back of continued capital flows due to strong investment and consumption themes driving overall growth of these economies.

Bull run continues on MSM

The MSM index gained 9.9 per cent in the four weeks between November 15 and December 14. In the first two weeks of December the index gained 6.2 per cent. Barring any portfolio-adjustment-led year-end-correction, this month could very well be one of the top return months. The index's returns in October were the highest (15.2 per cent) followed by May (6.8 per cent). The rally in the index has been broad based with huge increase in volumes indicating strong buying interest.

The turnover of MSM in November was RO377mn as against the 11-month average of RO209mn. For December, the turnover has already crossed RO409mn. Our last note focused on how strong earnings growth has kept valuations reasonable even with indices touching all-time highs. Since then the index has moved up over 800 points. The re-rating process and positive earnings outlook paint a bullish scenario for the stock market as we move into 2008. In addition, as more paper (Nawras, Voltamp Transformers, Takamul IPOs) hits the market in 2008, it will generally add to the market depth.

Mixed macro numbers

The economy continues be on a strong footing as apparent from corporate tax collections, which grew by 121 per cent for the first nine months of the year indicating buoyancy in corporate earnings. The corporate income tax rose to RO170.5mn as against RO85.4mn for the whole of 2006.

Declining oil production has constrained the full benefits of crude oil price increase. Crude oil production for the first nine months of 2007 fell by 4.5 per cent to 707,500 barrels per day. Oil revenues for the period declined by 10.5 per cent to RO2.92bn compared to RO3.27bn during the same period last year, while the government expenditure grew by 10.4 per cent to RO3.61bn as against RO3.27bn.

Current expenditure growth was reasonable at 5.2 per cent but the key driver here has been the investment expenditure, which has grown the fastest by 28.1 per cent to RO994mn as the government provides fiscal stimulus to the economy. As a result, the
fiscal surplus for the first nine months of 2007 is lower at RO957.3mn as against RO1.24bn in the corresponding period last year.

Budget 2008

As per media reports, the 2008 budget assumes a price of US$45 per barrel as against US$40 per barrel in 2007. The gross public revenue is projected at RO5.4bn while the expenditure is projected to grow by 20 per cent to RO5.8bn compared to the 2007 budgeted figure of RO4.89bn resulting in a planned deficit of RO400mn.

Key corporate developments

Ahli United Bank (AUB) has completed the acquisition of 35 per cent stake in Alliance Housing Bank (AHB). AHB has issued 113.1mn shares to AUB at RO0.450 per share, thereby bringing an additional capital of RO50mn. In order to meet the minimum capital requirement of RO50mn, the bank will increase the capital to RO64.6mn through a 1:1 bonus issue. The deal will be beneficial for AHB in treasury and trade-finance related businesses, though it might be difficult for the bank to directly compete with established commercial banks in the medium-term. We expect the bank to get a grace period of around two to three years to build its corporate loan book and to meet other lending related criteria.

In a classic case of competition prompting consolidation, Muscat Finance and National Finance are considering a merger. If the deal goes through, the combined entity will be one of the largest in the leasing space. Oman Flour Mills is planning to move up the value chain by setting up an industrial bakery at a cost of RO7mn. In addition, it has entered into a franchise agreement to set up kiosks and bakery cafés. Oman Cables, in association with Takamul Investment Company, is setting up a 48,000 metric tonne aluminium rod and conductor manufacturing plant in Sohar close to the aluminium smelter. Earlier this year, National Aluminium Products Company had announced plans to set up extrusion capacity in Sohar industrial area by drawing alumi-nium in molten form from the smelter. These developments are an indication of an indirect spin off of upstream activity, which is giving a leg up to ancillary activity. In sum, we can expect pockets of capex-led acceleration in corporate earnings.

Risks

Among the GCC markets, Saudi Arabia took off in the period under consideration gaining over 20 per cent. Noises made about a possible liberalisation of foreign investment norms generated lot of buying interest. On the flip side and on a structural note, softening of investment restrictions in KSA could lead to portfolio reallocations by GCC dedicated funds wherein other countries may lose out eventually. As far as MSM is concerned, we clearly acknowledge the risks to entry decisions taken at this point. These risks are more to do with possibility of a technical correction, which would be healthy so as to possibly bring in the money that is sitting on the fence for now. However, risks could also emanate from the composition of the set that is driving the market capitalisation in general, which are not necessarily the first-rung stocks. That said, long-term money, which is willing to bear the short-term volatility, would continue to find its way into the markets especially when valuations are not stretched vis-à-vis expected growth.