Solid Q2 Earnings Seen For Saudi Banks, Petrochemicals

Solid second-quarter earnings among Saudi Arabian banks and petrochemical companies may give the country’s stock market a boost in the second half of this year, analysts believe.

Those two sectors together account for over half of the market’s capitalisation, so they are key for the performance of the bourse. The market’s main index is up 11.9 per cent year-to-date, far underperforming rises of over 30 per cent by other Gulf markets such as Dubai and Kuwait.

Saudi bank shares have slightly outperformed other sectors; the banking index is up 15.2 per cent year-to-date. But banks’ earnings growth has been dampened by low interest rate margins and, to a lesser extent, by payment problems at some of their construction company clients.

Late last year the government began imposing fees on companies that hired more foreign workers than locals, in an effort to reduce unemployment among Saudi nationals. Construction firms have been among the hardest hit by the policy as their hiring costs have increased.

“Contractors are complaining of labour issues and this is affecting their ability to service debts,” said Asim Bukhtiar, head of research at Riyad Capital.

Saudi banks may have to take loan loss provisions for their exposure to construction firms in their second-quarter earnings, which will be announced in the next few weeks.

However, other factors are working in favour of the banks. Bank lending to the private sector surged 16.5 per cent from a year earlier in May, the fastest pace since February 2009, after a 16 per cent increase in the previous month, central bank data shows.

Riyad Capital estimates the banking sector’s net income will rise seven per cent from a year earlier for the second quarter, with Bank Aljazira posting growth of 19 per cent and Saudi British Bank a rise of five per cent.

Profits may start to climb faster if, as many expect, U.S. interest rates rise over the next year or two as the U.S. Federal Reserve scales back its stimulus policy. Because of Saudi Arabia’s currency peg to the dollar, Saudi lending rates would be likely to rise too, though with a lag; this could expand banks’ profit margins on their loans.

Saudi Arabia’s NCB Capital estimated in a research note that a small increase of just 0.1 percentage point in net interest margins for the ten banks it monitored would boost their net income by 4.6 per cent, leading to a 10.1 per cent increase in 2013 earnings.

PETROCHEMICALS

Meanwhile, export-focused petrochemical shares have been performing poorly mainly because of uncertainty about the global economy; the petrochemical sector’s index is up just 3.9 per cent year-to-date. But many companies have succeeded in improving their profit margins while additions to production capacity in recent months should push up sales volumes, offsetting a drop in product prices during the second quarter.

“I’m expecting good numbers for second quarter because margins should be higher,” said Iyad Ghulam, petrochemical analyst at NCB Capital.

“We’ve increased our price targets by an average of six per cent and remain overweight in some companies. Upside is lower than before (because of a recent rally by the shares) but overall, sentiment is positive.”

Saudi Arabia provides ultra-cheap natural gas to its petrochemical firms, giving them a competitive edge against global firms. Investors have been concerned that this subsidy could be scaled back in 2013 but there has been no official statement to that effect, so analysts now believe companies will continue to enjoy that cost advantage for the time being.

Concern about the global economy may continue to affect Saudi petrochemical stocks for some time. Kuwait-based NBK Capital said it was neutral on the sector for that reason.

“China’s credit crunch as well as the potential tapering of the Fed’s quantitative easing programme present some near-term downside risk to major chemical product prices,” it said.

Nevertheless, it forecast five per cent quarter-on-quarter and 30 per cent year-on-year growth in second-quarter earnings for six Saudi petrochemical firms which it covers.

Shares in Saudi Basic Industries Corp, the world’s largest chemical producer, closed at 92.25 riyals on Wednesday. NBK Capital says fair value for the stock is 106.50 riyals, while NCB Capital has a price target of 121.50 riyals.