Market becomes a victim of high expectations

Despite the best ever corporate results and corporate actions this year, the market is not enthused and the key indices continue to head south.

“During the past 8 quarters the market got so used to companies and banks declaring more than 100 per cent increase in profits with frequent bonuses or cash dividends. The expectations are so high that nothing short of a deep correction can now drive home the market realities to the UAE investors,” said an analyst with a local fund management company.

Brokers and other market intermediaries agree that fundamentally nothing has changed except that people want a higher rate of growth, while many are not convinced that the corporate results are sustainable in the medium term.

Oman Insurance Company posted Dh755 million profits in 2005, representing a 272 per cent increase from the previous year. The company underwrote more than Dh800 million in premium, up 51 per cent from Dh529 million last year. The company's shares continue to fall despite such sterling performance.

Arab Technical Construction Company (ATCC) reported 125 per cent increase in profits for the full year at Dh173m. With a large number of projects in hand the company is confident of repeating its performance.

Announcing the results, Shaikh Butti bin Maktoum bin Juma Al Maktoum, the Chairman of Arab Technical Construction Company said: "Through 2005, the property market within the UAE continued to witness new innovative projects. I believe that this positive trend will continue for the next few years."

The investing community is not convinced. Arabtec shares fell following the results.

The results from UAE banks have been excellent by any standards. The First Gulf Bank reported Dh1.06 billion up 331 per cent from the previous year. Bank of Sharjah’s profit was up 340 per cent at Dh602.8 million. Dubai Islamic Bank and Union National Bank have reported profit increase of 130 per cent and 155 per cent, respectively. Although FGB and DIB shares showed reported gains immediately after the results, the euphoria was short-lived.

In the UAE market it is a normal trend that shares flare up a few weeks ahead of the quarterly results and sober down as the market discount the results. For the year end results, the market has been virtually indifferent.

Why has the market turned so cold? Khaleej Times had reported that part of the problem is liquidity flight to other Gulf markets. There has been a huge liquidity drain from the market as Saudi investors pulled out close to Dh25 billion of their investments during the past four months. Of course, that alone does not explain the current investor apathy. "There is huge liquidity in the UAE market and it is likely to go up as the oil prices are surging," said Shehab Gergash, Managing Director of Daman.

Market analysts say UAE valuations are still attractive by Gulf standards. While the current UAE market P/E hovers around 24, Saudi is up at 28 while Oman, Bahrain and Kuwait have P/Es of 18, and 22 and 23 respectively.

"In the last quarter of 2005 the market corrected itself and the current valuations are not too high compared to the peak P/E of 38 in the middle of last year. It is more than valuation and I suspect there is a confidence issue on the sustainability of corporate results," said Abu Abdul Razak a regular at DFM.

Analysts and fund managers agree. “In some of the sectors like property, the domestic market is nearing saturation and if the property companies do not find overseas market it will be difficult for them to sustain their profits,” said a fund manager.

Despite the robust economic conditions prevailing in the country, many suspect the banks' ability to repeat the 3-digit profits growth many of them reported last year. It is a universally accepted fact that a big share of banking sector profits have come from capital markets. With the markets looking sluggish, the portfolios held by banks could prove to be a double edged sword. While on the one hand the declining values of these portfolios will reflect on the performance of banks, on the other hand any decline in performance will affect their share prices, dragging the markets further down.

Partly the declining investor confidence comes from the fear that many of these companies that reported huge profits from their market operations will not be able to repeat the same this year. Oman insurance for example has reported a 41 per cent increase in profits from its insurance operations while investment returns increased by more than 400 per cent. In the case of most banks which reported huge profits, the core-banking incomes are in the range of 25 to 40 per cent, while 'other incomes' are dominating the P&L statements.

Though many banks have reported huge increase in interest income, a good portion of it has come from high interest leverage provided to IPOs last year. In the case of fee-based incomes too, a major portion accounted for management fees for IPOs, rights issues and a few debt issues. “With the new regulations on IPO, companies with less than three years' track record are not allowed to float their shares. This will significantly affect the fee-based incomes of the investment banking divisions,” said an analyst.

A large number of rights issues that came to the market last year is also likely to work against the market this year. Apart from draining huge amounts of liquidity from the market, many leading fund managers suspect the ability of many of these companies to effectively deploy these funds