Kuwait's bull run to continue

The change of regime in Iraq and the new economic policies underlined by the new government would mean that not only the risk premium attached with Kuwait has seen permanent reduction but also the business environment is all set to record steady growth rates in the next couple of years.

Therefore the confidence shown by the investment community in the last couple of years is going to last for a longer time than it has in the past. With the expectations that oil prices are not going to come down substantially in the current year and with interest rate expectations continuing to remain low we believe the stock market activity will further grow in the current year, though achieving the returns it had last year will be difficult to replicate.

Despite having recorded substantial gains in the last three years, the KSE still looks cheap in valuation terms compared to its other GCC neighbours. The KSE also scores over its neighbouring bourses in terms of liquidity of stocks, expected profitability, depth of the stock market, etc.

As a result of its fundamental strengths the KSE is poised to attract more institutional and retail investors in the current year also despite the growth recorded by it in the last few years. Moving away from sentiments, we will try and examine the current fundamentals of the economy and various other factors, which might impact the performance of KSE in the next few months.

Investors all around the world have always got attracted to stable political and economic environments and we have already seen how the removal of the old regime in Baghdad has made a difference to Kuwait's economy and its stock markets.

A more stable political environment in Iraq will certainly further drive Kuwait's economy through increased trading and business which will lead to added purchasing power in the hands of the residents of Kuwait. All this will lead to increased prosperity for Kuwaiti economy for the times to come.

But this feel good factor can only be sustained if the government continues with the pending economic reforms which would make the current positive environment more conducive for private sector investments and doing business in Kuwait. The momentum created through the direction provided by the new government will have to be continued so that the investors continue to repose their faith in the economy and the capital markets.

The initial steps taken to solve issues like foreign investment, privatization, development of northern oil field and unemployment needs to be followed by bolder moves like reduction in subsidies, diversification of government revenues, rationalization of taxes, capital market reforms, etc. Policies which would help the private sector investment grow would certainly help the capital markets in Kuwait.

Even though the world economic recovery remains fragile, there are indications that we might very soon see a sustained economic growth in USA and Asia from where most of the growth in demand for oil is going to come from. The oil prices have continued to remain high as inventories are tight and so is OPEC spare capacity.

While politics in Venezuela, Nigeria and the Middle East has been comparatively cooler, the pre-emptive action being taken by OPEC has kept up the speculative influence so as to have a premium on oil prices. There are also suggestions that while there is an upside to demand growth at the same time there is also a downside to the non-OPEC supply.

There also has been talk about a slip off in oil prices towards the second quarter of 2004, but at the moment we don't think that is going to happen before the fourth quarter of 2004 when again the winters might keep the oil demand high. Riding on high oil prices both the government revenues and expenditure have expanded rapidly and so has the economic growth as measured by GDP of Kuwait.

After having contracted by an estimated 2% in 2002, the economic growth is estimated to have grown by more than 4% in 2003 and is expected to record a strong growth in 2004 as well. Any fall in oil prices would certainly impact government revenues as well as the current account surplus which in turn would affect the expenditure by the government and the consumer demand.

Even though the oil price is expected to decline in the coming fiscal year, it is likely to be compensated by an increase in oil production.

There could be several positives, which would come out of stability and a favourable government in Iraq including increase in trade and financial activity among the two nations leading to prosperity for both countries. Increase in the existing subcontracts from the Iraq rebuilding process should also benefit the Kuwaiti companies further.

Currently there are several large tourism, real estate and oil sector projects which are under consideration including the US$7bn oilfield development project in north Kuwait, two petrochemical facilities worth US$3bn, the Boubyan and Failaka island projects, etc. The spending on these projects would further stimulate the economy, which might spur consumer spending and result in domestic demand recording stronger growth in the coming years.

The interest rates are expected to remain low for a large part in the current year as the US Federal Reserve has not shown any recent signs to increase the interest rates, which might affect the economic recovery in that country.

Even if the interest rates are increased they would be minimal and not necessarily lead to an increase in interest rate in Kuwait as the interest rates in Kuwait are already higher than those in the USA despite the pegging of the currency. The continuance of lower interest rates would further spur investors interest in the real estate and other investment products including the stock markets.

Firm oil prices and continued UNCC payments indicate that liquidity would remain comfortable in the medium term. Though UNCC payments have slowed down, there have been some recent payments by the UNCC. January 2004 saw the UNCC disbursing US$125mn and the average disbursal has been approx. US$200mn for a 3 month time frame.

The money supply M2 has also grown by more than 7.5% in 2003. While some of the other key world stock markets have recorded higher growths compared to the losses they had in 2002, these growths have been modest compared to what we have seen in the regional markets in the last few years.

This has happened because of the investors reposing their faith in the local markets, but any substantial increase in the stock market performance of the developed countries particularly USA would certainly see the outflow of funds increasing. However a weaker dollar would certainly act as a deterrent to major outflow of funds and might also see a change in the portfolio mix which the regional investors have been using up till now.

But credit positive events like stability and increased trading activity with Iraq might mean that the economy would see increased economic activity and improved liquidity in the current year as well. Also the expected higher oil revenues in the current year will act as a deterrent in reducing the concerns about liquidity.

With the initial spending on the large oil, petrochemical and tourism projects beginning in 2004 and the government institutions continuing to support the market through the participation in various funds we don't foresee any liquidity problems in the medium term.

Recent expansion of the Kuwait economy and improved business environment as a result of the expected trade & business flow from Iraq seems to have permanently changed the fundamentals of a large number of Kuwaiti companies. Year 2003 saw the Kuwaiti corporate diversifying their revenue base by extending their operations beyond Kuwait.

The prime examples of such diversification have been the banks (National Bank of Kuwait, Gulf Bank, Kuwait Finance House, etc), mobile operators (MTC & NMTC), Transportation & Logistic companies (Public Warehousing, Transport Group, Kuwait Gulf Link Transport Companies), etc. Apart from these companies there have been several insurance, investment, real estate and industrial companies which have extended their operations beyond Kuwait.

As explained earlier the growth in the profitability of listed companies in Kuwait has been much more than the growth recorded by the stock exchange ("Global" General Index). The prime reason behind this could be the fact that the investors have already discounted the earnings growth recorded by the listed companies.

This is a good phenomena as it shows that the market is slowly getting sophisticated. Therefore we tend to think that the rise in stock markets is not purely a speculative phenomena, but is also backed by fundamentals. We strongly believe that the diversified income base and improved geopolitical scenario will help in keeping the local stock market upbeat for an extended period of time.

The attractiveness of the Kuwaiti market also stems from the liquidity in the stocks, which makes entry and exit comparatively smoother compared to its other regional counterparts. It is a prime factor which any investor whether retail or institutional takes into account before buying into a stock market. It has been amply demonstrated in the last few years by the growth recorded at KSE.

Its volume of shares traded stood at 49.7bn more than 6 times that of Saudi Arabia where the volume of shares traded was only 5.6bn. While those of other regional peers have been comparatively insignificant with that of Qatar being 0.2bn, Oman at 0.3bn, Bahrain being 0.4bn and UAE recording 0.6bn volume of shares traded.

A better measure of liquidity is the turnover of shares which also shows Kuwait ranking favourably among its GCC counterparts, second only to Saudi Arabia. With turnover of more than 250% and 165%, the Saudi Arabia stock exchange and the KSE respectively are the among the most liquid stock exchanges in the region.

Despite the substantial growth recorded by the Kuwait Stock Exchange (KSE), it appears undervalued compared to its regional peers. The substantial increase in profitability of corporates has also led to the comparative valuation look cheaper for Kuwait compared to its regional peers.

P/E comparisons show that the KSE is relatively cheaper at 13.4x compared to its regional peers barring Oman and Bahrain, which have a lower P/E than Kuwaiti equities. With the outlook for corporate profitability remaining strong we believe the KSE will see an extended bull run in the current year as well.

The diversification undergone by the services and the banking sector companies are certainly going to help these companies improve their profitability in the current year, which should be reflected in their valuations also. Investors looking for stable growth could look at large Banking stocks like National Bank of Kuwait, Kuwait Finance House, Gulf Bank & Commercial Bank which hold a lot of promise and could be considered as safe investments.

There could be also recovery and growth stories among the smaller banks like Burgan, BKME, KREB, etc. The insurance companies would also fall in the same category of safe investments with their higher dividend yields.

The telecommunication companies which have seen substantial increase in their share prices in the last couple of years are still the favourites with several new licenses being planned to be given out in the region. But the growth in the telecom stocks will be a function of how the telecom companies are able to manage their financing of these new projects and are able to improve their margins as well as profitability.

The other services sector stocks also look attractive particularly those in the logistics & warehousing business, retail businesses and hotels, etc. The year 2004 will see further growth both in the investment and the real estate sector backed by the lower interest rates and a bullish stock market.

But here the investors will have to be careful in differentiating between good and bad managements as well as look for companies which will be able to sustain their earnings when the stock markets decline.

Another set of companies which the investors can focus in the short to medium term will be the cement/building material companies as these companies apart from their investment portfolio have a very profitable core business which is doing well due to improved cement prices and increased demand as a result of the construction boom.