Expanding horizons; opportunities in growing Middle East bourses

Some non-Gulf neighbours have built respected bourses with proven results, but the real opportunities might rest with the younger, growing markets.

Jordan once joined Egypt and Morocco on MSCI Barra's list of emerging markets, but poor performance led to a drop in its ratings in 2008.

Investors, especially in the Gulf, might be inclined to turn their noses up at stock markets in North Africa and the rest of the Middle East. Compared to the Arabian Peninsula, one of the richest places on earth, other parts of the region can seem like poor relations best avoided. The non-Gulf economies do pose certain dangers due to their comparative lack of development, global money managers acknowledge. But advocates find the markets dynamic, broadly diversified, welcoming, laden with opportunity and therefore worth the risk.

In hindsight, the opportunity has been there for quite a while. Long-term investors in the two big North African bourses have been rewarded generously. Egypt produced a total return (price appreciation plus dividend payments) of 371 per cent during the decade through last December, according to a study by Michael Hartnett, chief global equity strategist at Banc of America Securities-Merrill Lynch. Mature markets had trouble scratching together any gain at all over the same period.

Morocco was no slouch either. Although it lost 5 per cent in 2009, a good year for global markets, its total return for the decade was 173 per cent. One possible reason for the weakness last year is that Morocco fell just 13 per cent in 2008, far less than almost all other markets. Smaller Middle East and North African markets also show prodigious returns, although very long-term performance histories can be hard to come by. The MSCI Barra index of shares in Jordan was recently up 116 per cent for the last 10 years, even after losing about half its value during the second half of that period. Over the last five years, the MSCI indices for Lebanon and Tunisia have done much better, showing gains of 137 per cent and 93 per cent, respectively.

The main attraction of non-Gulf MENA is not the economic accomplishments that have been made but the prospect of cashing in on achievements to come. The strong returns have been rung up even as development remains embryonic relative to Western economies and the larger emerging ones. The key is that progress is continuing and still has a long way to go. Large, young and rapidly expanding populations should allow these burgeoning economies to successfully advance on the path to development, devotees say, and to take investors along for the ride.

Some markets in the region appear to have entered a sweet spot now that they have established track records. Corporate and economic information and forecasts are fairly widely available from analysts so that foreigners are not flying blind, yet there is not so much of it that more intrepid investors who want to put in the legwork can't get an edge on their rivals. "A good thing about those markets is that they're not heavily researched, so many of the stocks are quite interesting and attractive at this stage of the game," said Mark Mobius, executive chairman of Templeton Asset Management.

Another reason that global investors may covet these markets is that the markets covet them. Government entities and businesses in the Gulf obtain most of the capital they need by selling oil and gas, so capital markets are not as vital to the functioning of their economies. Not so to the northwest. With industrial bases and infrastructure less developed in the rest of MENA, and with comparatively little revenue generated from exports, investment is needed more.

That makes companies in an eclectic assortment of industries more eager to list on stock exchanges. It also encourages authorities to run their bourses in ways that appeal to foreign institutions - efficiently, transparently and with a regulatory stringency that strives for equal treatment of all investors. That openness and diversification have persuaded MSCI Barra, a compiler of stock indices widely followed by the global investment community, to confer "emerging market" status on the Egyptian and Moroccan bourses, while none in the Gulf Co-operation Council is deemed to qualify. Portfolio managers often need that mark of respectability from an established index firm to give them cover when putting money into more obscure markets.

MSCI announced in mid-2008 that it was demoting Jordan from emerging to frontier status. That may account for some of that market's poor performance during the last five years - it was the worst non-Gulf MENA bourse - although certain developments in Jordan may have prompted MSCI's move also. While fledgling economies like these tend to be fast growers, the growth often comes at a price of inconsistency and chronic imbalances. That can produce extreme stock market volatility and the occasional scary, unsettling loss.

Non-Gulf MENA countries - which means non-oil MENA nations - are plagued by fiscal and current-account deficits because they have little to trade with the world and their treasuries have little revenue coming in. Inflation, high interest rates and high unemployment can be chronic maladies. That can leave little to cushion the blow in hard times, such as the last few years, and scarcely any margin for error.

That compels many investors to tread cautiously and helps explain why non-Gulf MENA markets often trade on lower valuations than more mature bourses. The more precarious state of Egypt's economy, for instance, is why Joe Kawkabani, managing director for asset management at Algebra Capital, said he has "lower conviction" about its market's prospects. "I like the domestic economy in Egypt," he said. "Government demand is strong, however I don't think that's sustainable for the long run because Egypt is not as rich as the Gulf. If the global economy doesn't recover, the momentum will weaken." Egyptian stocks could have "another leg to stand on" later this year, he added, if it becomes clear that the global economy is recovering.

One leg on which Egypt's stock market is perched - certainty about the political backdrop - has shown signs of wobbling. Egyptian shares fell roughly 7 per cent in barely more than a week recently after President Hosni Mubarak had gallbladder surgery. Such shocks to the system can often be good times to buy in emerging markets, though, and that's how Hasnain Malik, who follows Egypt for Citigroup, regards this decline.

"Health concerns are not unusual for octogenarians or the Egyptian market," Mr Malik said in a note to the bank's clients. Pointing out that the surgery went well and that Mr Mubarak has plenty of time to recover and contest the election scheduled for late next year, Mr Malik added that "short-term succession risks are overblown." The sellers, he said, are ignoring "Egypt's long-term positive investment case" - the country's strong, steady march toward development and economic liberalisation. Tame inflation, a stable currency and valuations about one-third lower than the emerging market universe should help smooth out any short-term bumps, in his view.

Citi has buy ratings on three Egyptian blue chips: Talaat Mostafa, a developer of hotels and residential housing, including ElRehab City, which is expected to provide 46,000 housing units in Cairo; Orascom Construction, whose cost-cutting programme has strongly improved profit margins; and Orascom Telecom, its high-tech cousin with activities in mobile phone and internet services across Africa and in Pakistan, Bangladesh and Canada.

Sergey Fedoseev, an analyst at HSBC, has an "overweight" rating, equivalent to a buy, on Orascom Telecom. The stock has suffered from a plethora of woes in several of its markets, including weak business conditions in Pakistan and disputes in Algeria, Canada and Egypt. As Mr Fedoseev sees things, the bad news is priced in, while the scope for improvement from resolutions to the various problems is not.

Elsewhere in the region, Citi recommends buying Solidere, a Lebanese property developer deemed comparatively safe because it is well capitalised and pays out much of its earnings as dividends; Jordan Phosphates; and the airline operator Royal Jordanian. Don Elefson, co-manager of the Harding Loevner Frontier Emerging Markets Fund, likes Jordanian Arab Bank, which he called "a quality bank in a quality country," noting that Jordan is known as "the Switzerland of the Middle East."

The sobriquet is not a reference to Jordan's chalets and broad mountain vistas, but to its reputation for safety in an often perilous region. The bank does well for itself holding Iraqi and Palestinian money, Mr Elefson said. Another bank he likes is Audi, a Lebanese institution expanding rapidly in North Africa. Templeton owns Audi in its portfolios, along with Orascom Construction. Both are among the five largest of 80 holdings in the Templeton Frontier Fund. Another selection is Poulina Group, a conglomerate in Tunisia with interests in food and beverages, and Mr Mobius said he is sizing up prospects in Morocco and, of all places, Libya.

"We're finding a lot of well managed companies that know what they're doing," he said. In a tacit acknowledgement that non-Gulf MENA is still a work-in-progress, though, he added, "They're quite good in terms of possibilities." Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain", can be found at http://bit.ly/NjaBa