nbk capital-mena infocus-08may2011similar developments have been at work in currency markets....

Issue no. 83 - May 08, 2011

nbkcapi ta l .com

MENAinFocus

Inside This Issue

In Focus 1: The Return of Inflation: The Valuation Paradox

Since the start of the recovery in emerging markets in mid-FY2009, inflation has been rising at a steady pace. Most leading economies have started taking measures to fight it. Economic theory tells us that this should lead to readjustments in the valuation of the different asset classes, with rising long bond yields triggering corrections in equity and property markets. Yet, although the resurgence of inflation has been present for a while, few readjustments have occurred. In our opinion, this is largely the result of i) quantitative easing (QE), and ii) temporary external shocks. With QE2’s end approaching in the US, and the program unlikely to be extended, what is in store for asset valuations globally, and what are the implications for the MENA region?

By: Loic Pelichet

In Focus 2: UAE Real Estate: Little Promise in the Near Term

While Dubai appears to have overbuilt, Abu Dhabi was simply late to the game, and consequently, the emirate’s development boom was rather momentary. Oversupply, price correction, and additional rental yield weakness are characteristics of United Arab Emirates (UAE) residential and commercial real estate. Weak investor confidence and financing constraints continue to weigh on these two segments. Prospects for the hospitality and retail sectors remain healthy given the rise in tourist inflows for leisure as well as business purposes and the region’s shopping reputation. Going forward, the economic environment and the government policies to attract and retain expats as well as foreign investors play a vital role in determining the demand dynamics in the UAE real estate sector.

By: Mala Pancholia

Rebased Performance of Regional Indices

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Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11

S&P Pan Arab Large/Mid Composite S&P GCC Large/Mid Composite MSCI Jordan+Egypt+Morocco

MENA Market Caps

0%

1%

1%

2%

2%

3%

7%

7%

13%

12%

14%

37%

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Palestine

Tunisia

Lebanon

Oman

Bahrain

Jordan

Egypt

Morocco

Qatar

Kuwait

UAE

Saudi Arabia

(%) Share of MENA Market Cap Market Cap. (USD billion)

Summary of Performance of MENA Indices

Index Level as of

30-Apr-11% below

52-Week High% over

52-Week Low1-Mth Period YTD

REGIONAL

S&P Pan Arab Large/Mid Composite 132 135 112 -2.4% 17.6% 3.3% -0.8% 981S&P GCC Large/Mid Composite 137 137 111 -0.1% 23.4% 4.5% 2.6% 776MSCI Jordan+Egypt+Morocco 1,151 1,501 1,129 -23.3% 2.0% -4.5% -19.6% 161

GCC

MSCI Bahrain 292 336 261 -13.3% 11.5% 0.9% -0.1% 20MSCI Kuwait 954 966 665 -1.3% 43.5% 9.9% 0.0% 117MSCI Oman 1,069 1,165 945 -8.2% 13.1% 5.6% -4.8% 19MSCI Qatar 1,010 1,030 742 -1.9% 36.1% 4.0% 5.3% 125S&P Saudi Arabia Large/Mid Composite 158 158 124 -0.2% 27.4% 2.6% 3.1% 359MSCI UAE 257 263 200 -2.5% 28.6% 9.6% 3.8% 136

OTHER MENA

MSCI Egypt 1,257 1,905 1,214 -34.0% 3.5% -6.8% -28.4% 63MSCI Jordan 233 269 223 -13.3% 4.6% 2.3% -6.3% 29MSCI Morocco 795 827 658 -3.9% 20.8% -0.7% 4.7% 69MSCI Lebanon 1,059 1,223 1,052 -13.4% 0.7% -0.6% -4.4% 11MSCI Tunisia 1,262 1,588 1,132 -20.6% 11.5% 0.9% -9.7% 9Palestine SE 496 519 481 -4.4% 3.2% -0.6% 0.7% 3

Market Cap (USD

billions)

INDEX 52-Week

High52-Week

Low

% Change

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MENAinFocusMay 08, 2011

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ThE RETuRN oF INFlATIoN: ThE vAluATIoN PARAdox

Since the start of the recovery in emerging markets in mid-FY2009, inflation has been rising at a steady pace, in both developed and emerging markets. Most leading economies have started taking measures to fight it. Economic theory tells us that this should lead, all other things being equal, to readjustments in the valuation of the different asset classes, with rising long bond yields triggering corrections in equity and property markets. Yet, although the resurgence of inflation has been present for a while, few readjustments have occurred. Although long bond yields have risen since the start of 2011, they remain very low by historic standards. Equity valuations are high, curiously highest in those regions currently experiencing the highest bouts of inflation, whilst property prices are holding up in most markets. In our opinion, this is largely the result of i) quantitative easing (QE), especially in the United States (US), which has kept bond yields artificially low, thereby forcing investors into riskier asset classes, and ii) temporary external shocks (Middle East and North Africa [MENA] unrest, European Union [EU] debt crisis). With QE2’s end approaching in the US, and the program unlikely to be extended, what is in store for asset valuations globally, and what are the implications for the MENA region?

The Return of Inflation

Figure 1-1 World CPI Trends

Country Group Name Subject Descriptor 2009 2010 2011 2012

World Inflation, average 2.459 3.744 4.458 3.441World Inflation, end of period 2.973 4.101 4.222 3.126Advanced economies Inflation, average 0.14 1.557 2.23 1.671Advanced economies Inflation, end of period 0.998 1.878 2.108 1.591Emerging and developing economies Inflation, average 5.185 6.206 6.87 5.278Emerging and developing economies Inflation, end of period 5.297 6.606 6.508 4.717Middle East and North Africa Inflation, average 6.532 6.905 9.966 7.302

Source: IMF, World Economic Forum Database, April 2011.

There are signs that some government or public entities are starting to view this inflationary bout as more significant than just a temporary blip:

• China has started taking energetic measures to contain inflation, including recently raising mandatory reserve requirements for banks to a record 20.5%, as well as talks from the Chinese Central Bank of controlled Yuan appreciation to fight imported inflation;

• The European Central Bank (ECB), despite the debt crisis in peripheral EU economies and the EU’s relatively low inflation (2.7% in March 2011), has raised its leading rate 25 basis points (bps).

Others are still standing by. The United Kingdom (UK), where both the CPI and Retail Prices Index (RPI) have widely exceeded targets in the past six months, has yet to tighten rates (partly, in our opinion, as some of the recent rise in inflation reflects rises in value added tax [VAT]). The same goes for the United States, which still has a stimulatory bias, with QE2 still in progress. However, in both these countries increasing voices are being heard, within the rate-setting committees of both the Bank of England (BoE) and the Federal Reserve Board (the Fed), arguing for more tightening bias.

IN FOCUS 1

Inflation, as measured by the

Consumer Price Index (CPI),

has been on the rise since

mid-FY2009

Loic Pelichet

T.+971 4365 2818E. [email protected]


mailto:loic.pelichet%40nbkcapital.com?subject=



The Market is Sending Contradictory Signals

Economic theory tells us that, in a world of resurging inflation, safe assets will tend to see their value increase, whilst riskier assets should adjust downwards, to reflect an increasing required rate of return on the part of investors (who tend to look at real returns, thus requiring a rise in nominal required returns).

Commodities, and gold in particular, have conformed to theory.

Figure 1-2 Price of Gold

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Sources: Bloomberg and NBK Capital Research

We view gold as a more significant yardstick. Industrial commodities and food prices strengthen as a result of increased demand, and tend to be an explanatory factor of inflation. Gold prices, there against do not primarily reflect the industrial usage of gold but rather its safe haven status.

Figure 1-3 Commodity Prices

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Similar developments have been at work in currency markets. Traditional refuge currencies (Swiss franc, CHF) have risen strongly, and currencies of countries that have started fighting inflation (euro [EUR], Chinese yuan [CHY]) have also held firm.

Yet other asset classes have acted as though the inflationary push has hardly existed.

Long bond yields, while up from the all-time lows seen in FY2010, are still very low by historical standards.

Figure 1-4 Historical Long Bond Yields

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Note: we have used South Korea as a proxy for the Asian region; no Korean data available before 2000. Sources: OECD,

Bloomberg, and NBK Capital Research

Equity markets have also held up remarkably well, following their strong FY2010 performance. More interestingly, equity valuations are highest in areas experiencing the highest bouts of inflation (emerging market valuations are much higher than those in developed markets).

Figure 1-5 Equity Market Valuations

Index PE 2011 EV/EBITDA 2011

Bombay Sensex 30 21.6 15.3Shanghai SE Composite 17.5 11FTSE Eurotop 100 13.1 13DJI 14.2 9.5


Finally, commercial property yields have held up in most markets (only slight corrections have been seen in some emerging markets [China], mostly engineered by worried governments).




So Why has This happened?

There are, in our view, three main reasons why asset markets have been reluctant to react to the surge in inflation.

1. The main reason, in our opinion, has been the extremely accommodating monetary policy adopted by developed economies in response to the financial and banking crisis of FY2007-2008. This has taken the form of extremely low nominal intervention rates (Fed Funds currently at 0.25%, for instance), as well as quantitative easing in the US and the UK (with the Central Bank buying long-term bonds on the open market, thereby keeping long-term rates very low, and injecting liquidity). This has effectively forced investors into riskier assets, as traditional risk-free assets (mainly LT bonds) have offered negative real returns for more than a year now. In effect, the liquidity injected by developed markets’ central banks has been denied any potential returns in the less-risky part of the market, forcing it to chase riskier returns. Interestingly, the correlation between asset markets and QE programs can be seen in market reaction to external shocks. As the chart below demonstrates, the Greek debt crisis was met by a sharp sell-off. But the Irish and Portuguese crises, although equally significant in strictly economic terms, have passed relatively unnoticed. It is interesting to observe that the former coincided with the end of QE1, and uncertainties about QE2, while the latter happened with QE2 progressing at full steam.

Figure 1-6 Equity Markets and External Shocks

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Greek default crisisQE1 ending June 2010

Irish default crisisQE2 on-going to August 2011


2. External shocks have muddied the picture. Political unrest in the MENA region, as well as successive EU debt crises, have effectively removed further asset classes from investors’ reach, concentrating abundant liquidity on yet fewer asset classes. A demonstration of this can be seen in the bond market’s reaction to recent events: in spite of the ECB tightening (and thus, theoretically, reducing the risk of runaway inflation) and the US remaining ultra-accommodating, it was US long yields that eased. This was mainly due to EU debt worries.

3. Inflation is still perceived by some governments (and thus, by some investors) as a temporary danger. Indeed, wage settlements in most developed economies have not reflected increased inflationary expectations (although such developments were seen in selected emerging




markets, particularly in the MENA region). Sharp-ish budgetary policies in most areas of the world (though interestingly, again not in the USA) have also contributed to temporary inflationary spikes.

So What happens Now?

We expect to see two main developments in the near future on the global front:

1. First and foremost, it is looking increasingly likely that the days of the ultra-accommodating monetary policy in the USA are nearing their end. QE2 is expected to finish in August 2011, and is very unlikely to be extended into QE3. This should go at least some way toward addressing the distortions in asset markets witnessed recently.

2. Tightening monetary and budgetary policies are set to continue in selected emerging markets (e.g., China), as well as in the EU. Equally, the USA is likely to experience some form of budgetary tightening in the years ahead, although the political situation (Republicans in control of the House, with a Democratic President and Senate) means the scope of the tightening is difficult to predict. This in turn should lead to a slowdown in world economic growth, and thus to a reversal in commodity prices and a slowdown in inflation. However, the lag between tightening and the resulting slowdown in activity is typically 6 to 12 months.

In the short term, thus, the main impact on asset markets should be that of the end of QE. All else being equal, this should result in the following:

• A potentially significant rise in long bond yields, led by the USA;

• A corresponding strengthening of the USD.

In theory, this should result in a downward correction is other asset prices. However, we believe the impact of a rise in long bond yields will, in the short term at least, be mitigated. This is mainly due to the artificially low levels at which bond yields, both short and long, have been held in developed markets. This means that the yield differentials, for both property and equities, have been historically high. In other words, all else being equal, other asset markets have not entirely reflected the very low bond yields, probably reflecting markets’ perception of the temporary nature of lower yields.

Figure 1-7 Prime Office Yields vs. Long Bond Yields

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Sources: CBRE and NBK Capital Research




The above chart shows that, whilst the yield differential contracted sharply in the boom years, it started expanding again as soon as the banking crisis started in mid-FY2007. Crucially, throughout FY2010, the yield differential remained at historically high levels: despite the rising inflation rates, prime office yields remained roughly unchanged, whilst long bond yields continued declining. In view of the historically high yield differential, we feel there is potential for long bond yields to re-adjust upwards initially, without a corresponding adjustment needed in property yields.

For equities, another mitigating factor is at play. Following the financial crisis of FY2007-2008, companies have aggressively de-geared their balance sheets. However, spare capacity remains available, at least in developed markets. Therefore, it is very likely in our view that free cash flows will be directed toward increasing yields (be it through increased dividend levels, or share buy-backs), at least in the short to medium term. Indeed, a recent Standard & Poor’s (S&P) study points to exactly this happening in the USA:

• Since the beginning of FY2011, 117 companies in the S&P500 have announced they would raise or start dividend payments.

• Financial companies have announced USD7 billion in dividend increases.

• Ten companies announced they would start paying dividends in 1Q2011, the highest level since FY2003.

Thus, we feel that, in the short term at least, rising dividend yields could accommodate rising long bond yields, underpinning equity markets.

Overall thus, our preferred scenario for the short to medium term is that of a sharp correction in bond markets, particularly in the developed world, a firming of developed markets’ currencies (certainly as far as the USD and GBP are concerned), but a relatively benign effect on property and equity markets.

In the longer run, two possible scenarios emerge:

• Inflationary expectations do take hold in labor markets, and pay settlements start rising, while more restrictive policies start slowing down growth. This could be the case particularly if the world’s major debtors pursue a soft policy to inflate their way out of debt. It could also be the result of political pressure in selected emerging markets, with governments buying their way out of trouble (indeed, this seems to be happening to a certain point in the MENA region). In such a scenario, all asset classes would suffer, but property and, to a lesser extent, equities would be favored.

• Tightening policies, especially in emerging markets, lead to a global soft landing for both GDP growth and inflation, whilst wage growth remains moderate. Here, commodities, and gold in particular, would be the main sufferers, whilst property would be the main beneficiary.

Implications for the MENA Region

The MENA region possesses a few idiosyncrasies that render an analysis of the effects of inflation a bit more difficult to quantify, particularly when contemplating the Gulf Cooperation Council (GCC):

• As a major oil producer, the region actually benefits from higher world inflation, in terms of massive supplementary export revenues;

• However, since the region is a net importer of almost all other commodities, and particularly food, higher oil prices also translate into significantly accelerating inflation;

• Recent political unrest in the region has led some governments to take measures that actively stoke domestic inflation, even if it is currently at high historical levels. Saudi Arabia has announced two massive spending programs, increasing public-service salaries and pumping huge sums into the economy, particularly the housing market. In Egypt, recent political protest have also led to salary rises;




• The region’s bond markets, public and corporate, are small and, in some cases, non-existent;

• Finally, property markets are either showing strong signs of over-supply (United Arab Emirates [UAE], Qatar) or have severely restricted access (Saudi Arabia).

The recent political troubles are not helping the region’s asset markets, at least from a foreign capital inflow perspective. This is hampering selective markets (e.g., the Egyptian property market, although backed by some of the strongest fundamentals in the region, is unlikely to see much inflows in the near future).

As we have noted, in the short to medium term, a correction in the bond market is likely to provide some underpinning to equities and property. If, as the first tentative signs appear to show, political uncertainty starts subsiding, selected regional equity markets should benefit, particularly Egypt (less oil dependent, valuation battered by recent events). Eventually, property markets with strong fundamentals and relatively open access (again, Egypt comes to mind), should also pick up. Theoretically, UAE property markets should also see benefits; however, the supply overhang there means the markets are fundamentally unbalanced.

Inversely, a period of successful tightening by both developed and emerging economies should theoretically result in dropping commodity prices and a firmer (or at least stabilizing) USD. This should impact oil-driven equity markets (e.g., the GCC).

Overall, however, the combination of some economic slowdown and persisting political uncertainty will likely result in an unfavorable investment environment within the MENA region over the next six months.




uAE REAl ESTATE: lITTlE PRoMISE IN ThE NEAR TERM

Within this piece, we focus mainly on the Dubai and Abu Dhabi real estate markets, which together account for 70% of the country’s population. While Dubai appears to have overbuilt, and is thus facing a deeper impact of the downturn, Abu Dhabi was simply late to the game, and consequently, the emirate’s development boom was rather momentary. In Dubai’s residential and commercial segments, prices and rents continue to slide as supply mounts. Similarly, in Abu Dhabi, with the exception of the undersupplied prime office space segment, the trend in the residential and low-grade office segments is similar to that of Dubai. Prospects for the hospitality and retail sectors remain healthy across the country, particularly in Dubai. Given the country’s large expat population (80%), government policies to attract and retain expats as well as foreign investors play a vital role in determining the demand dynamics in the UAE real estate sector. Going forward, we feel that Dubai’s higher quality supply and better infrastructure could make it a regional winner.

dubai Residential Real Estate

• Jones Lang LaSalle (JLL) observed the following: 1) by the end of 2010, Dubai had a supply of approximately 309,300 residential units, 2) by the end of 2012, 49,000 additional units are likely to hit the market, and 3) by the end of 2011, apartments will account for more than 75% of the new supply.

• Given that the population of the emirate is 1.94 million (Dubai Statistics Center), and assuming 50% are white collar (family size, 3.5 persons) and the remaining 50% are blue collar (housing size, 10 persons), we calculate a residential oversupply of 10% by the end of FY2010. By 2012, if demand remains constant, the inflow of new units could aggravate oversupply to 22%.

• Colliers indicates that in 4Q2010 the blended average house price in Dubai was AED 961 per ft2, 50% below the 2008 peak (AED 1,919 per ft2).

• In the largely expat-driven emirate, caution dominates sentiment given the continued job insecurity. Residential oversupply and tight credit lead to further demand weakness. Exorbitantly high service charges (15%-40% of the yearly rent) only compound the crisis.

• Given the above conditions, the decline in rental yields is hardly surprising. Global Property Guide indicates that residential rental yields in the “New” Dubai averaged 5.5%-6.5% in 3Q2010 versus 8.5%-10% back in 2007-2008 (Colliers, Dubai Real Estate 2Q2008).

IN FOCUS 2

Mala Pancholia

T.+971 4365 2811E. [email protected]


mailto:mala.pancholia%40nbkcapital.com?subject=



Figure 2-1 Dubai Residential Real Estate Market Seeks Stability Following the Crash

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Sources: Colliers, JLL, and NBK Capital Research

dubai Commercial Real Estate

• Despite some improvement in the economic conditions in Dubai, weak demand and oversupply continue to impact commercial space sales prices and lease rates unconstructively.

• According to JLL’s 1Q2011 report, Dubai has a supply of 60.2 million ft2 of office space and another 14 million ft2 could be completed by the end of 2011. By 2013, Dubai is expected to have 81 million ft2 of commercial office space to offer.

• In 1Q2011, the vacancy rate in Dubai was 44% (27% Commercial Business District [CBD]), which is likely to swell to 50% as the new supply hits the market by the end of 2011.

• The current prime office rent of AED 150 per ft2 has declined 62.5% since its peak (the end of 2008).

• Lease rates have declined 33% year-on-year (YoY), according to JLL, as tenants continue to revisit their cost base given the weak market fundamentals. It is widely accepted that office rents in Dubai are likely to head south (10%-20% according to JLL) in the near-term.

• Given its well-established infrastructure, Dubai is an obvious choice for businesses targeting the region. The declining rent is an incentive that further strengthens the Dubai offering.

• While rental yields in the Central Business District (CBD) remained fairly attractive in 1Q2011 at 10%-14% (20%-25% in 2008), average rental yields across the city were down to 6%-12% (15%-18% in 2008).

• The average price of prime office space in Dubai was AED 1,040 per ft2 in 1Q2011, having declined 64% since the peak in 2008 (AED 2,900 per ft2). Contrary to the global trend of rising capital values, JLL points to a further 10%-20% price correction in the near-term.

Although prices have stabilized

in select developments, rents

continue to slide across the

emirate. Additional supply

could further weaken market

dynamics




Figure 2-2 Dubai Commercial Real Estate Market Yet to Find a Bottom

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dubai Retail Real Estate Market

• According to the CB Richard Ellis (CBRE) retail survey, Dubai is one the top five shopping destinations globally, hence attracting a large number of international retailers. Cushman and Wakefield noted that shopping malls top the demand for retail space. However, international retailers remain cautious and are retiming their expansionary agendas as regional economic growth prospects remain uneven in the near-term.

• JLL estimates that as of 1Q2011 the total retail space on offer in Dubai was about 26.5 million ft2. Average vacancy rates were 15%-30%. An additional 5.5 million ft2 is slated for completion during 2011-2013; however, additional mega-malls are unlikely.

• Although average retail rents have declined at a compound annual growth rate (CAGR) of 28% since the end of 2008 to AED 175 per ft2 per annum for malls in 1Q2011, JLL observed that popular malls tend to command a 30%-40% premium versus smaller retail offerings. Rents could ease further if tourist activity drops or if the regional appetite for shopping declines.

• Emaar’s malls witnessed footfall of 3.0-3.5 million per month until 3Q2010, versus Mall of Emirates (2 million), Deira City Center (1.5 million), and Ibn Batuta Mall (1 million) back in 2008. Therefore, despite a grim regional economic outlook, the Dubai retail sector continues to remain lucrative, which explains the relatively lower correction in retail rents.

While geopolitical concerns

could cushion demand in the

near-term, they are unlikely

to offset the rapidly rising

vacancy rate. Rental yields

and capital values still have a

downside risk




Figure 2-3 Dubai Retains Its Retail Hot Spot Status

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dubai hospitality Market

• Dubai’s Department of Tourism and Commerce Marketing (DTCM) announced that in 2010, tourist arrivals were up 10% YoY to 8.6 million and the emirate’s tourism revenue rose 6.5% YoY to AED 13.2 billion. While the number of visitors has increased since 2008 (7.5 million), tourism revenue has declined from the high of AED 15.25 billion.

• According to DTCM, the Dubai hotel room supply was 51,000 rooms. Smith Travel Research’s (STR) February report noted that Dubai has an additional 28,474 hotel rooms in the pipeline. However, given the liquidity crunch in the real estate sector, construction delays are expected. JLL estimated an additional 12,500 rooms will come on stream by 2013. The bulk of the additions are likely to be in the luxury/super-luxury segment.

• According to STR, occupancy levels in Dubai hotels improved in 1Q2011 to about 82%, in line with the 2007-2008 levels (84%-79%), versus the decline to 79% and 74% in 1Q2010 and 1Q2009, respectively.

• The average daily rate (ADR) is down from the high of AED 1,310 in 2008 to AED 910 in 1Q2011 (about a 31% decline).

• With Dubai’s unique offering, tourist numbers are likely to rise, thus leading to stability in occupancy rates, which in turn are likely to buoy the declining ADRs, especially at favorably located hotels—beachfront, downtown, Old Town, etc. However, rates at city hotels could remain pressured given lower demand.

A regional shopping appetite

ensures Dubai’s retail sector

attractiveness. However, a

correction in lease rates and

incentives cannot be ruled out

as landlords seek to attract

international retailers




Figure 2-4 Dubai Hospitality Sector Gains Momentum

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Abu dhabi Residential Real Estate

• Abu Dhabi’s real estate development boom was rather brief. Since FY2009, developers have opted to rescale growth plans, and delays and cancellations have been typical.

• While 2007-2008 was characterized by a shortage of residential space, mostly low-quality units on offer, and a huge supply pipeline to meet latent demand, the hiccups of 2009-2010 have led to manageable demand-supply dynamics; however, segmental imbalance remains.

• According to JLL, Abu Dhabi’s current residential inventory is 188,000 units. By the end of 2011, 16,000 additional units are likely to be completed, and by the end of 2013, the total supply of residential units could rise to 250,000 units (68% apartments).

• Prices for residential properties across the capital have corrected remarkably since the crash of 2008. The average price per square foot for a two-bedroom apartment in Abu Dhabi dropped to AED 1,100 at the end of 2010 from a high of AED 2,000-3,000 in 2008.

• Soft demand from highly price-sensitive buyers and an overall weak investor appetite continue to be a letdown for the Abu Dhabi real estate sector in the near- to mid-term.

• JLL pointed out that additional downward pressure on rents is expected given 1) the increasing supply of upscale and/or new better-quality units and 2) the declining rents in Dubai. Average rents in the capital have declined 40% since mid-2008. In 1Q2011, the average annual rent for a two-bedroom apartment dropped to AED 140,000 versus AED 231,000 in 2008, while the average annual rent for a three-bedroom villa in the capital is AED 175,000 (down 35%-50% since the peak in 2008).

Rising tourist traffic

proves beneficial for the

hotel industry. A revival in

occupancy rates could buoy

the declining room rates,

especially in tourists’ preferred

locations




Figure 2-5 Abu Dhabi Average Prices Stabilize While Average Rents Could Decline Further

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2500

Mid 2008 End 2008 Mid 2009 End 2009 Mid 2010 End 2010

Average Price (AED) per sq. ft. for 2BR Apartment Average Rent for 2BR Apartment '000s AED per annum

Sources: JLL, CBRE, and NBK Capital Research

Abu dhabi Commercial Real Estate

• Of the 2.3 million m2 of commercial space available in the capital, barely 15% meets international quality standards and can be considered prime. Shortages back in 2007-2008 led to the conversion of residential buildings (old inferior structures) into low-grade offices, inadvertently raising residential rents.

• By the end of 2013, the supply of commercial space in the capital is likely to expand to 3.5 million m2. JLL indicates that the current supply pipeline would address the shortage of prime office space.

• However, going forward the total commercial space expansion is likely to lead to higher vacancy rates across the city (1% in 2008 rose to 5% in early 2010 and 10.4% in 1Q2011).

• Office demand primarily stems from government entities or state-owned corporations. Both groups tend to be owners of their office buildings, thus the dearth of sales transactions in the capital. In the near- to mid-term, the tenant profile in Abu Dhabi is unlikely to change much.

• The average lease rate for prime office space has declined about 48% since the end of 2008 to AED 177 per ft2. The average rents for lower-grade offices have fallen about 45%-50% to AED 112 per ft2 since the end of 2007.

• In the near- to mid-term, given the abundant supply of high-quality commercial space in Dubai, rents across the Abu Dhabi office market will likely be pressured downward. JLL also noted that the rent gap between prime office space and low-grade office space is likely to widen as rent depreciation in the latter category intensifies.

Although prices in the capital

appear to have stabilized

of late, the demand-supply

mismatch could pressure the

average rents downward in the

near- to mid-term




Figure 2- 6 Average Lease Rates for Prime Office Space are Likely to be Pressured

353

279260

205186

177

50

100

150

200

250

300

350

400

End 2008 Mid 2009 End 2009 Mid 2010 End 2010 1Q2011

Average Lease Rate for High-Grade Office Space (AED) per sq. ft. per annum

Sources: JLL and NBK Capital Research

Abu dhabi Retail Real Estate Market

• The total retail gross leasable area (GLA) in Abu Dhabi at the end of 2010 was about 1.5 million m2, only 37% of which was occupied by retail malls. By the end of 2013, 600,000 m2 additional leasable area is to be added to the supply in the emirate.

• In 1Q2011, JLL estimated that the popular Abu Dhabi malls enjoyed relatively high occupancy rates of 95%. At the end of 9M2010, Colliers pointed to an average occupancy rate across the emirate of about 85%.

• Interest in leasing space in the capital appears to be on the rise given the city’s high income per capita, expanding resident retail spending, and rising tourist traffic.

• Given that retail demand originates primarily from the Abu Dhabi Island, retail space at malls therein command a 40%-50% premium versus retail outlets at other locations.

• Retail rents in the Abu Dhabi Island have stabilized since 3Q2009 versus a declining trend in other city locations. In 1Q2011, the average rent in the Abu Dhabi Island was AED 256 per ft2 per annum while average rent in other island locations was AED 112 per ft2 per annum. We note here that although Abu Dhabi retail rents appear much higher than those prevalent in Dubai, the capital’s GLA is barely 5.6% of that of the region’s retail capital (Dubai).

• JLL pointed to a potential softening of rents in the near- to mid-term, given the 40% surge in the supply of retail space expected in the next two to three years, especially in the mall segments.

Government policies involving

1) an enhanced economic

framework to attract foreign

businesses and 2) relocation

of offices from residential

premises to commercial could

prop up the commercial real

estate sector in the capital




Figure 2-7 Abu Dhabi Island Retail Rents Stabilize since 3Q2009

302

294

279

256 256 256 256 256 256 256

230

240

250

260

270

280

290

300

310

4Q 2008 1Q 2009 2Q 2009 3Q 2009 4Q 2009 1Q 2010 2Q 2010 3Q 2010 4Q 2010 1Q2011

AED per sq.ft. per annum

Sources: JLL, Colliers, and NBK Capital Research

Abu dhabi hospitality Market

• According to the Abu Dhabi Tourism Authority (ADTA), the number of visitors to the emirate has doubled over the past eight years to 1.8 million in 2010 (up 18% YoY). By 2013-2015, the number of hotel guests is expected to rise to 2.4-3.0 million per year.

• By the end of 2010, the supply of hotels rooms in Abu Dhabi stood at 10,000 (a 45% increase since 2008). Another 9,700 rooms are likely to come on stream during 2011-2013. However, in the near- to mid-term, construction delays and cancellations could ensue.

• Despite enhanced leisure offerings (e.g., F1 Grand Prix) since 2009, 80% of the visitors to Abu Dhabi in 2010 were business focused. In the near-term, the visitor profile is largely expected to be geared to business tourism rather than leisure.

• Although 2010 saw a rise in tourist traffic, occupancy rates across the emirate remained lackluster (59%). While early 2011 saw a remarkable revival in occupancy rates (67% and 74% in February and March 2011, respectively; STR), it is too early to ascertain if the recovery trend is sustainable or simply a derivative of the regional uncertainty.

• According to STR Global, the average room rates in Abu Dhabi in February 2011 were USD 222, 2.7% higher than in FY2010 but 28% below 2008 levels.

• While the number of visitors to Abu Dhabi could rise in line with expectations given the emirate’s better economic prospects, the rising supply in the capital could lead to lower occupancy levels, thus pressuring average rates downward in the near-term.

The increasing supply of

mall retail space in strategic

locations could lead to

softening of rents in the near-

to mid-term




Figure 2-8 Abu Dhabi Hospitality Market Remains Lackluster versus Dubai

110

88 89 89 89 91

117

167

238

309294

216222

64%67% 67% 68% 68%

82%85% 84%

81% 81%

73%

59%

74%

30%

40%

50%

60%

70%

80%

90%

100%

50

100

150

200

250

300

350

1994-99 2001 2003 2005 2007 2009 1Q2011

Average Rate, USD Average RevPAR, USD Occupancy

Sources: HVS Middle East Hotel Survey, STR Global, JLL, and NBK Capital Research

Oversupply, price correction, and additional rental yield weakness are characteristics of United Arab Emirates (UAE) residential and commercial real estate. Weak investor confidence and financing constraints continue to weigh on the sector for the most part. In comparison, given the rise in tourist inflow for leisure as well as business purposes and the region’s shopping reputation, prospects for the hospitality and retail sectors remain healthy across the country, particularly in Dubai. With Dubai’s high-quality supply and well-developed infrastructure, the capital’s residential and commercial segments (currently dominated by a supply of old inferior structures) are likely to face intense competition. Given a largely expat-driven (80%) workforce, the economic environment of the country and the government policies to attract and retain expats as well as foreign investors play a vital role in determining the demand dynamics in the UAE real estate sector.

Despite the growing number

of tourist attractions in Abu

Dhabi, 2010 was the weakest

year for the city’s hotel

industry as occupancy slid to

59%, leading to a 27% YoY

decline in average rates




CoMPANIES IN FoCuS (PRICES AS oF APRIl 30, 2011)

T12M 2011 2012 Latest 2011 2012

Banking

Abu Dhabi Commercial Bank UAE AED 2.92 26-Apr-11 2.40 Hold 19.1 12.0 7.3 0.7 0.7 0.6

Arab National Bank Saudi Arabia SAR 33.40 11-Apr-11 36.20 Hold 15.2 13.0 11.4 1.9 1.7 1.5

BankMuscat Oman OMR 0.772 14-Apr-11 0.760 Hold 11.4 11.4 9.7 1.5 1.3 1.2

Banque Saudi Fransi Saudi Arabia SAR 46.40 12-Apr-11 55.30 Accumulate 12.0 11.5 10.2 1.9 1.7 1.5

Doha Bank Qatar QAR 51.70 19-Apr-11 62.00 Accumulate 9.7 9.2 8.0 1.7 1.5 1.5

First Gulf Bank UAE AED 18.20 26-Apr-11 18.80 Accumulate 8.1 7.2 6.0 1.1 1.0 0.9

National Bank of Abu Dhabi UAE AED 11.25 19-Apr-11 12.40 Accumulate 9.0 8.2 7.1 1.3 1.2 1.0

National Bank of Oman Oman OMR 0.312 18-Apr-11 0.340 Accumulate 11.9 11.7 10.5 1.3 1.2 1.1

Qatar National Bank Qatar QAR 136.50 24-Apr-11 133.60 Hold 14.1 12.6 10.8 3.6 2.1 1.8

Riyad Bank Saudi Arabia SAR 26.00 10-Apr-11 33.70 Buy 13.5 12.8 11.3 1.4 1.3 1.2

Samba Financial Group Saudi Arabia SAR 55.75 13-Apr-11 61.90 Accumulate 11.5 11.2 10.3 1.9 1.7 1.5

The Commercial Bank of Qatar Qatar QAR 73.20 20-Apr-11 97.00 Buy 10.8 10.6 9.3 1.4 1.3 1.2

The Saudi British Bank Saudi Arabia SAR 45.50 11-Apr-11 47.90 Accumulate 16.9 15.1 12.7 2.2 2.0 1.8

Union National Bank UAE AED 3.60 28-Apr-11 3.80 Accumulate 6.3 5.4 4.7 0.7 0.7 0.6

Sector Country CurrencyClosing Price

Recommendation12-Month Fair Value

PBDate of Last Report

PE

T12M 2011 2012 T12M 2011 2012

Building Materials

Ezz Dekheila Steel Egypt EGP 564.87 9.4 na na 6.2 na na

Ezz Steel Egypt EGP 8.02 14.2 na na 6.4 na na

Lecico Egypt EGP 15.90 10.1 na na 6.4 na na

Oman Cement Co. Oman OMR 0.590 16-Jan-11 0.700 Accumulate 8.8 11.5 11.4 10.9 9.2 9.2

Ras Al Khaimah Cement Co. UAE AED 1.03 21-Feb-10 1.06 Hold 7.2 27.9 28.4 26.4 14.4 14.2

Raysut Cement Co. Oman OMR 1.097 11.6 na na 10.3 na na

Qatar National Cement Co. Qatar QAR 112.00 09-Feb-11 91.00 Reduce 10.7 9.9 9.9 8.9 8.8 8.9

Contractors

Arabtec UAE AED 1.43 13-Apr-11 1.50 Hold 7.0 9.2 8.2 4.0 4.9 4.8

DEPA UAE USD 0.60 05-May-11 0.73 Buy nmf 10.0 9.1 nmf 6.2 6.1

Drake and Scull UAE AED 1.05 14-Apr-11 1.02 Hold 15.7 12.2 10.7 11.5 8.7 8.0

Orascom Construction Egypt EGP 241.72 15.0 na na 10.1 na na

Real Estate Mabanee Kuwait KWD 0.780 01-Mar-11 0.809 Buy 21.0 15.6 16.0 19.2 15.2 14.0

Salhia Real Estate Co. Kuwait KWD 0.208 10.3 na na 7.8 na na

Telecommunications

Bahrain Telecommunications Co. Bahrain BHD 0.484 21-Apr-11 0.660 Buy 8.7 7.4 7.7 4.5 4.4 4.5

du UAE AED 3.26 01-May-11 3.59 Accumulate 13.8 18.2 15.3 7.6 6.6 5.5

Etihad Etisalat Co. Saudi Arabia SAR 53.50 21-Apr-11 70.00 Buy 8.3 8.1 7.4 6.6 6.2 5.7

Egyptian Company for Mobile Svcs. Egypt EGP 143.14 10.5 na na 4.7 na na

Jordan Telecom Grp. Jordan JOD 5.44 02-May-11 4.35 Reduce 14.8 14.0 13.9 6.1 5.8 5.7

Oman Telecommunications Co. Oman OMR 1.114 09-Feb-11 1.450 Accumulate 7.5 9.5 10.5 3.8 4.1 4.2

Qatar Telecom Qatar QAR 157.50 01-May-11 181.00 Accumulate 10.3 8.1 8.1 3.8 3.8 3.7

Saudi Telecom Saudi Arabia SAR 36.30 7.9 na na 4.7 na na

Telecom Egypt Egypt EGP 16.35 9.4 na na 6.0 na na

Vodafone Qatar Qatar QAR 7.96 nmf na na nmf na na

Wataniya Telecom Kuwait KWD 2.020 24-Apr-11 2.240 Accumulate 12.5 13.2 13.5 4.4 4.7 4.6

Nawras Oman OMR 0.749 21-Apr-11 0.900 Accumulate 10.1 9.1 9.0 5.4 4.9 4.6

Transportation & Logistics

Agility Kuwait KWD 0.425 17.7 na na 4.0 na na

Air Arabia UAE AED 0.74 05-May-11 0.80 Accumulate 11.6 19.6 15.9 6.4 6.5 3.8

Aramex UAE AED 1.89 26-Apr-11 1.95 Hold 11.1 13.2 12.3 7.9 7.7 7.2

DP World UAE USD 0.67 05-Apr-11 0.67 Accumulate 29.8 29.5 25.1 13.2 13.4 12.4

Jazeera Airways Kuwait KWD 0.120 nmf na na 8.7 na na

Others

Almarai Saudi Arabia SAR 93.75 06-Apr-11 117.00 Buy 16.8 15.7 13.3 13.6 12.8 10.8

Dana Gas UAE AED 0.68 36.1 na na 8.5 na na

GB Auto Egypt EGP 28.43 13.5 na na 7.4 na na

Oriental Weavers Egypt EGP 31.50 8.8 na na 7.0 na na

Juhayna Egypt EGP 5.41 17.2 na na 10.6 na na

Qatar Electricity and Water Co. Qatar QAR 147.40 21-Apr-11 144.00 Hold 11.8 12.1 11.4 13.2 12.5 11.8

Savola Saudi Arabia SAR 28.00 15.8 na na 11.0 na na

The Sultan Center* Kuwait KWD 0.122 nmf na na 11.1 na na

Sector Country CurrencyClosing Price

Under Review

12-Month Fair Value

Under Review

Under Review

Under Review

Under Review

Under Review

Under Review

EV/EBITDAPE

Under Review

Under Review

Date of Last Report

Under Review

Recommendation

Under Review

Under Review

Under Review

Under Review

Under Review

Under Review

Under Review

Under Review

*Adjusted




RISK ANd RECoMMENdATIoN GuIdE

RECoMMENdATIoN uPSIdE (doWNSIdE) PoTENTIAl

BUY MORE THAN 20%

ACCUMULATE BETWEEN 5% AND 20%

HOLD BETWEEN -10% AND 5%

REDUCE BETWEEN -25% AND -10%

SELL LESS THAN -25%

RISK lEvEl

loW RISK hIGh RISK

1 2 3 4 5

dISClAIMER

The information, opinions, tools, and materials contained in this report (the “Content”) are not addressed to, or intended for publication, distribution to, or use by, any individual or legal entity who is a citizen or resident of or domiciled in any jurisdiction where such distribution, publication, availability, or use would constitute a breach of the laws or regulations of such jurisdiction or that would require Watani Investment Company KSCC (“NBK Capital”) or its subsidiaries or its affiliates to obtain licenses, approvals, or permissions from the regulatory bodies or authorities of such jurisdiction. The Content, unless expressly mentioned otherwise, is under copyright to NBK Capital. Neither the Content nor any copy of it may be in any way reproduced, amended, transmitted to, copied, or distributed to any other party without the prior express written consent of NBK Capital. All trademarks, service marks, and logos used in this report are trademarks or service marks or registered trademarks or registered service marks of NBK Capital.

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The Content shall not be considered investment, legal, accounting, or tax advice or a representation that any investment or strategy is suitable or appropriate for your individual circumstances or otherwise constitutes a personal recommendation to you. NBK Capital does not offer advice on the tax consequences of investments, and you are advised to contact an independent tax adviser.

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Kuwait

National Bank of Kuwait SAKAbdullah Al-Ahmed StreetP.O. Box 95, Safat 13001Kuwait City, KuwaitT. +965 2242 2011F. +965 2243 1888Telex: 22043-22451 NATBANK

INTERNATIoNAl NETWoRK

Bahrain

National Bank of Kuwait SAKBahrain BranchSeef Tower, Al-Seef DistrictP.O. Box 5290, Manama, BahrainT. +973 17 583 333F. +973 17 587 111

Saudi Arabia

National Bank of Kuwait SAKJeddah BranchAl-Andalus Street, Red Sea PlazaP.O. Box 15385Jeddah 21444, Saudi ArabiaT. +966 2 653 8600F. +966 2 653 8653

United Arab Emirates

National Bank of Kuwait SAKDubai BranchSheikh Rashed Road, Port Saeed Area, ACICO Business ParkP.O. Box 88867, DubaiUnited Arab EmiratesT. +971 4 2929 222F. +971 4 2943 337

Jordan

National Bank of Kuwait SAKHead OfficeAl Hajj Mohd Abdul Rahim StreetHijazi Plaza, Building # 70P.O.Box 941297,Amman -11194, JordanT. +962 6 580 0400F. +962 6 580 0441

Lebanon

National Bank of Kuwait(Lebanon) SALSanayeh Head OfficeBAC Building, Justinian StreetP.O. Box 11-5727, Riyad El Solh1107 2200 Beirut, LebanonT. +961 1 759 700F. +961 1 747 866

Iraq

Credit Bank of IraqStreet 9, Building 187Sadoon Street, District 102P.O.Box 3420, Baghdad, IraqT. +964 1 7182198/7191944 +964 1 7188406/7171673F. +964 1 7170156

Egypt

Al Watany Bank of Egypt13 Al Themar StreetGameat Al Dowal AlArabiaFouad Mohie El Din SquareMohandessin, Giza, EgyptT. +202 333 888 16/17F. +202 333 79302

United States of America

National Bank of Kuwait SAKNew York Branch299 Park Avenue, 17th FloorNew York, NY 10171, USAT. +1 212 303 9800F. +1 212 319 8269

United Kingdom

National Bank of Kuwait (Intl.) PlcHead Office13 George Street,London W1U 3QJ, UKT. +44 20 7224 2277F. +44 20 7224 2101

NBK InvestmentManagement Limited13 George StreetLondon W1U 3QJ, UKT. +44 20 7224 2288F. +44 20 7224 2102

France

National Bank of Kuwait (Intl.) PlcParis Branch90 Avenue des Champs-Elysees75008 Paris, FranceT. +33 1 5659 8600F. +33 1 5659 8623

Singapore

National Bank of Kuwait SAKSingapore Branch9 Raffles Place #51-01/02Republic Plaza, Singapore 048619T. +65 6222 5348F. +65 6224 5438

Vietnam

National Bank of Kuwait SAKVietnam Representative OfficeRoom 2006, Sun Wah Tower115 Nguyen Hue Blvd, District 1Ho Chi Minh City, VietnamT. +84 8 3827 8008F. +84 8 3827 8009

China

National Bank of Kuwait SAKShanghai Representative OfficeSuite 1003, 10th Floor,Azia Center, 1233 Lujiazui Ring Rd.Shanghai 200120, ChinaT. +86 21 6888 1092F. +86 21 5047 1011

ASSoCIATES

Qatar

International Bank of Qatar (QSC)Suhaim bin Hamad StreetP.O.Box 2001Doha, QatarT. +974 447 3700F. +974 447 3710

Turkey

Turkish BankHead OfficeValikonagl Avenue No. 1P.O.Box 34371 Nisantasi,Istanbul, TurkeyT. +90 212 373 6373F. +90 212 225 0353

NATIoNAl BANK oF KuWAIT

Kuwait

Head Office38th Floor, Arraya IIAl Shuhada Street, Block 6, SharqP.O.Box 4950, Safat 13050KuwaitT. +965 2224 6900F. +965 2224 6905

MENA Research35th Floor, Arraya IIAl Shuhada Street, Block 6, SharqP.O.Box 4950, Safat 13050, KuwaitT. +965 2224 6663F. +965 2224 6905E. [email protected]

Brokerage37th Floor, Arraya IIAl Shuhada Street, Block 6, SharqP.O.Box 4950, Safat 13050, KuwaitT. +965 2224 6964F. +965 2224 6978E. [email protected]

United Arab Emirates

NBK Capital LimitedPrecinct Building 3, Office 404Dubai International Financial CenterP.O.Box 506506Dubai, UAET. +971 4 365 2800F. +971 4 365 2805

Turkey

NBK CapitalArastima ve Musavirlik AS,Sun Plaza, 30th Floor,Dereboyu Sk. No.24Maslak 34398, Istanbul, TurkeyT. +90 212 276 5400F. +90 212 276 5401

NBK CAPITAl


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