THE MUSCAT SECURITIES MARKET

 

The Muscat Securities Market is the official market for trading in corporate securities and Government Bonds. Established in 1988, trading in the Market started in 1989, with 31 listed companies and a market capitalization of R.O. 264.3 million. At present, the Market facilitates trading in 132 local companies, 11 Government Development Bonds and 2 mutual funds. Apart from the above, there are 113 closely held companies listed on the market.   

MARKET CAPITALIZATION AND GDP

The Muscat Securities Market is one of the fastest developing markets among the GCC countries, its market capitalization as a percentage of GDP (at current prices) increased from 37.7 per cent in 2004 to 59.5 percent in 2007. There was marked improvement in turnover too, as market turnover witnessed 81.3 per cent growth in 2007 over the previous year. However, liquidity remained a major concern as turnover as a percentage of market capitalization on an average remained in the vicinity of 21.3 per cent over the last five years and was slightly higher at 22 per cent during 2007.  This is far low compared to other GCC markets (except Bahrain) as well as other developing markets. As oil prices continued a sharp uptrend during most part of 2008, the GDP is expected to be as high as RO 17.5 billion, while market capitalization and turnover may further improve to RO 11.6 billion and RO 3 billion, respectively. 

  

THE NEW ISSUE MARKET

During the past couple of years a number of small to large sized projects were promoted by the local industrial groups and investment holding companies.  The Muscat Securities Market played a key role in mobilizing domestic savings and channeling them as investment in prospective projects. Capital raised by both existing and new companies including capitalization of retained earnings increased steadily from RO 28.5 million in 1989 to RO208.8 million in 1994 and further to RO 439.9 million in 1998.  However, on account of the crash and depressed condition of the market during 1999 to 2001, the amount of capital raised was lower as compared to the previous years.  The market again witnessed huge increase in capital raised since 2003 and touched a high of RO 678.5 million in 2005 from RO 385.2 million in 2003. During 2006 and 2007, the total capital raised by companies was RO 385 million and 434 million, respectively. 

 

PRICE APPRECIATION IN THE MARKET

The Muscat Securities Market remained the best performing market in the GCC region during 2007. It witnessed strong valuation growth during 2007 as the benchmark MSM 30 Index appreciated by 61.88 per cent. The Banks & Investment Sector Index recorded the highest appreciation of 71.50 per cent, followed by the Industry Sector Index with an appreciation of 60.41 per cent and the Service & Insurance Sector Index with an appreciation of 52.03 per cent. On an average, the market has appreciated by 37.3 per cent over the last 5 years. 

Despite the global credit crisis and recession fear, we expect the market to revive, as the market currently remained highly undervalued.

  

KEY EARNINGS AND VALUATION INDICATORS

Strong price appreciation has driven the valuation levels on the Muscat Securities Market from an earnings yield of 8.3 per cent in 2006 to 7.74 per cent in 2007, despite a growth in earnings of approximately 30.4 per cent, over the same period. Based on the economic fundamentals, however, an earnings yield of 7.74 per cent to the 2007 estimated earnings is still healthy compared to other GCC and developing markets. An expected dividend yield of 4.72 per cent and price to book value ratio of 2.91 based on 2007 corporate results and closing prices are also quite attractive. 

In the beginning of 2008, the Market has responded well to the underlying valuation drivers of the corporate sector. Against the backdrop of a 12 per cent GDP growth and further policy liberalization to attract investments from other GCC and foreign countries, corporate sector earnings are expected to improve further from an average return on equity of 20.25 per cent for 2007 to 22.5 percent for 2008. Despite dilution in share capital both on account of further fund raising and stock dividends by a number of companies, the return on share capital is still going to improve further to 40.1 per cent in 2008 from 38.5 per cent in 2007.  In line with the above, return on asset is also going to improve further to 4.87 per cent in 2008 from 4.65 per cent in 2007.  

Though the market witnessed strong year-to-date price appreciation during the first half, the US sub-prime crisis, its overheated real estate markets and global economic slowdown amidst higher inflation, all had a negative impact on the Muscat Securities Market as well. As a number of high profile mortgage and investment banks in the US and Europe started crumbling and falling to their feet, markets around the globe started falling like a pack of cards.

The Muscat Securities Market continued to witness spells of sharp decline during the following months and volatility increased to a record high. The MSM 30 Index which had touched its highest level of 12,109.1 points with a year-to-date appreciation of 34.02% on June 11, 2008, has witnessed a major trend reversal over the past few months touching a year-to-date low of 7,900.62 points on September 16, 2008, losing 34.75% from its peak and 12.56% on a year-to-date count. The worst impact was noticed in the Industry Sector which had gained as much as 63.35% as on its July 15, 2008 peak of 13,291.75, but lost all its earlier gains to a year-to-date loss of 1.38% as on September 16, 2008. The Banks & Investment Sector also lost its year-to-date gain of 31.79% from its peak of 16,227.19 points on June 8, 2008 and slipped into negative territory by 20.06% on a year-to-date count as on September 16, 2008. The Services & Insurance Sector which recorded the least impact of the global market meltdown, lost its year-to-date highest gain of 48.45% as on July 15, 2008, to as low as 5.29% on September 16, 2008.  The Muscat Securities Market recovered a little bit since then until the market closed on September 29, 2008 for Eid. On a month-to-date count, during September 2008, the MSM 30 Index declined by another 10.54%, the Industry Sector by 10.64%, the Banks & Investment Sector by 10.42% and the Service & Insurance Sector by 6.83%.  

We believe the panic selling pressure is more of an overreaction to global market conditions and have little or no relevance to the underlying macro and corporate fundamentals of Oman.

  

FUTURE PROSPECTS

Macro-economic Baseline Scenario

So far, the Omani economyís performance this year has been commendable and we are expecting a real GDP growth of 13.9% per annum for the current year. This growth has come, however, at a high inflation cost of around 12.2% per annum and obviously, the economy may not continue to grow at this pace as inflation needs to be controlled before it becomes counter-productive. The Central Bank of Oman is closely monitoring the liquidity, interest rate and inflation situation and has taken a number of steps in the recent past to curb inflation and overheating in the financial system. It is in this context, that we are expecting inflation to moderate around 10.5% per annum in 2009, based on which, a real GDP growth rate of 3.4% per annum for 2009 is achievable.  On the commodities front, though in all likelihood oil prices will witness further softening in the range of US$ 80-90 a barrel and as a result may have some adverse impact on the oil revenue earned by the Government exchequer, since oil price of US$ 45 a barrel has been used for this yearís budget, it may not adversely affect the Governmentís spending on infrastructure and other development. Moreover, since the Omani Rial is pegged to the US Dollar, the loss on account of fall in oil prices to a significant extent will be compensated by a rising Dollar. Expecting that the US economy may take a year to gradually recover from its current conditions, the Omani economy should witness a higher real GDP growth of around 5.8% in 2010.  As far as the expected softening of other commodities is concerned, it will help in bringing down global inflation and thus will reduce the import-induced inflation which Oman has noticed since the last 3 years. 

Valuation Trail Continues

After the recent sharp fall, the Muscat Securities Market has become the cheapest market as per the key valuation indicators based on last two years corporate earnings trend. If we take into account corporate earnings growth in the Muscat Securities Market over the past two years, the market has become all the more attractive as valuation growth in the Muscat Securities Market continues to trail behind corporate earnings growth, keeping the Price-to-Earnings Growth (PEG) ratio at <1.    

2007 VALUATION TRAIL

Sector/Index

Index

Composition (2007) %

Last valuation trail (based on 2006

 earnings vs. valuation growth

2007 Corporate

Earnings Growth

2007 Valuation

Growth

Expected valuation growth

based on earnings growth

Valuation trail 2007

Banks & Investment Sector

53.46

7.60%

68.70%

71.50%

76.30%

-4.80%

Industry Sector

16.38

31.90%

73.40%

60.40%

105.30%

-44.90%

Services and Insurance Sector

30.16

-2.10%

57.80%

52.03%

55.70%

-3.67%

Market

100

8.7%

66.20%

61.88%

74.84%

-12.96%

 As far as the overall market is concerned, valuation was trailing behind 2007 earnings growth by 12.96%, mainly on account of a 44.9% valuation trail in the Industry Sector, while valuation levels of the other two sectors were also trailing behind marginally.  If we take into account the 2008 first half earnings growth and look at the current scenario, the overall market valuation level is 64.42% behind its earnings growth. The valuation trail is more pronounced at 83.86% for the Industry Sector, followed by the Services & Insurance Sector at 53.92% and the Banks & Investment Sector at 50.54%. 

2008 VALUATION TRAIL 

 

Sector/Index

Index

Composition (Dec 2007)

Current earnings growth

(2008 QII over 2007 QII)

Actual Valuation growth 2008 (YTD)

September 29, 2008

Current Valuation trail

Banks & Investment Sector

52.2

34%

-11.74%

-50.54%

Industry Sector

17.8

46%

7.04%

-83.86%

Services and Insurance Sector

31

63%

12.75%

-53.92%

Market (MSM 30)

100

45.5%

-6.0%

-64.42%

 

Valuation Growth Prospects and Rationality

As mentioned earlier, from a macroeconomic perspective, the Omani economy witnessed strong GDP growth over the last few years. Average real GDP growth from 2003 to 2007 was a healthy 12.4% and during 2008 it is expected to be around 13.9%.  Yes, inflation at around 12.2% is a major concern and can have a dampening effect on the economy; however, most of the recent inflation is imported as commodities prices had skyrocketed over the past years. With the expected easing of oil and gas and other commodity prices, as well as strengthening of the US Dollar, inflation is expected to recede. So while economic growth in Oman may gradually slow down, there is no immediate concern that it will have a strong and sudden negative impact on corporate earnings. We had mentioned earlier that, the imposition of certain restrictions by the Central Bank of Oman in the recent past were primarily aimed at curbing excess liquidity in the financial system and containing inflation. The Central Bank of Oman has increased cash reserve ratio from 5% to 8% from August 1 and reduced lending to deposit ratio of banks from 87.5% to 85% from August 1. These, in addition to the lowering of interest rates on personal loans from 8.5% to 8% with immediate effect, may have an adverse impact on the commercial banksí interest spread in the short-term, but will not impact their profitability as their top line growth rates are still very high.  Moreover, a falling interest regime will reduce the borrowing costs of companies  engaged in the industrial and services sectors and as such will improve their bottom lines, which in turn may be able to more than compensate the decline in their top line growth.  So in totality, the net impact of gradual slowdown of the economy may not be highly adverse, unlike the way the market valuation levels have nose-dived in the recent past.  Even if corporate earnings growth slows down by 10-15% by 2009, there is still enough room for further valuation appreciation, as valuation levels have never been able to match corporate earnings growth in the past 3-4 years.  

In a falling interest rate regime, the gap between real interest rate and expected equity risk premium widens. Keeping in view that the long-term average equity risk premium has remained constant at around 7 per cent, on a 2% interest rate yield basis, the average market P/E ratio should be around 11.1. The negative correlation between falling interest rates and equity value is often attributed to changes in the discount rate, the so-called denominator effect in a valuation model. But expected payoffs, the numerator in a valuation model also changes according to changing interest rates. Revising discount rates in a valuation model in response to changes in interest rates is quite a straightforward matter; however, it is not so easy to calculate the impact of changes in interest rates on cost of production, sales, earnings and residual earnings. Typically, investors tend to discount real cash flows using nominal interest rates, which may lead to valuation errors.  Equities are undervalued relative to bonds when the earnings yield (earnings to price (E/P) ratio exceeds the nominal bond yield and overvalued relative to bonds when the earnings yield is below the nominal bond yield.  The Muscat Securities Marketís earnings yield was a healthy 7.9% in September, based on 2008 earnings estimates, while the Central Bank of Omanís CD Repo rate, which can be used as a proxy to current bond yield, was 4.28% in September 2008.   

Typically, growth markets such as the Muscat Securities Market have much higher expected equity premium as they are linked to the macro growth trends and we believe that the Muscat Securities Market is currently trading at a discount of 15-20% to its underlying earnings expectations.