Saudi Underperformance Pins Lacklustre Earnings Season And A New Zakat Regime

Dubai:Tadawul banking index has pulled back sharply in the last two weeks, losing around 4.4 per cent since the beginning of February after selling pressure intensified on the back of less positive earnings seasons, weaker January banking/ economic data points and as the verdict date on final resolution on Zakat liabilities draws close. Q4 earnings was a dry spell, with the aggregate net profit of the banks declined 7 per cent sequentially driven by weak business volumes, non-interest income, and a marginal increase in loan impairments.

We note that 6 banks out of the 12 banks missed consensus by average 22 per cent, the intensity of the miss appears to have widened compared to previous quarters. The good news came from margins, which expanded 7 bps Quarter on Quarter and 30 bps Year on Year in Q4. However lending growth continued to disappoint (-1.9 per cent sequentially), while deposits inched up 1 per cent.

On consensus, BSF (driven by higher-than-anticipated provisions), SABB (due to higher-than-anticipated provisions) and SAMBA (lower- than-expected fee income) reported the biggest earnings miss. Added to this, January has not provided a great start either; as per the latest banking sector monthly data, the sector profitability dipped 4 per cent YoY on the bank of continuing weak credit demand, lower fee income (due to the lack of incremental credit), and higher provisions on the back of IFRS 9. Additionally, lending growth for January-2018 also remained sluggish (-0.6 per cent Year on year); credit growth to private sector declined for the 11th consecutive month, the longest we have seen over a decade.

As we had pinned it before, we suspect the credit activity to likely remain depressed in 1H18, however we expect Q3/Q4 to remain crucial as we anticipate the government project financing to kick start, paving way to a reasonable increase in loan book (+2 per cent in 2018E). January banking sector data, also revealed deposits increased 1.2 per cent YoY, and we expect this flush liquidity trends to broadly continue, and will be continued to be deployed in investments in government sukuk (+7 per cent in 2017) given the weak credit appetite.

Additionally, the value of point of sale transactions were down 19 per cent in January (over December), as consumers possibly engaged in essential spending (December) before- VAT implementation. Not just that, January data also pointed to the decline in foreign reserves by $1.9 billion to $495 billion (on the back of sequential increase in the last three months of 2017), a sign that government is digging in to the reserves to finance its budget deficit. The last, but the key concern that has had the undivided attention of the investors over the last few weeks is the new Zakat ordeal.

It is a long drawn dispute between Saudi banks and the General Authority of Zakat and Taxes (GAZT) on a disallowance on certain long term investments. The banks are contesting for $2.6 billion in total and if the verdict goes in favour of the Authorities, then the banking sector has to cough up this amount, which is equivalent to 2.8 per cent of banking sector equity. Although, this will not pass through the income statement (most likely an one-time hit to the bank’s equity), but is likely to be substantial for some banks, and less so for others. Based on our calculations, the most impacted will be Riyad (9 per cent), Alinma (8 per cent) and Albilad (8.1 per cent) while NCB will have a nil impact. On valuations, Saudi banks’ trade at 1.2x P/B 2018E, with an implied RoE of 11 per cent, slightly shy on the profitability metric of MSCI EM-banks (1.2x, RoE 13.3 per cent).

A fundamental catalyst for Saudi banks is yet to evolve, in our view and we don’t see anything beyond a limited margin expansion, for this year. Weaker credit appetite, non-interest income losing steam and a mild deterioration in the asset quality will likely cap the earnings growth at mid-single digit. However the valuations will be supported by technical/structural catalysts, and banking sector remains one of the better way to take advantage of expected flows into the Saudi market when included in the FTSE and MSCI EM indices.