UAE – Encouraging Outlook, But The Risk-Reward Isn't Great (NASDAQ:UAE) – Seeking Alpha

Panoramic view of the golden sand illuminated by the setting sun in the JBR beach area. Amazing skyscrapers and warm waters of the Persian Gulf are waiting for guests and tourists

frantic00/iStock via Getty Images

frantic00/iStock via Getty Images
The iShares MSCI UAE ETF (NASDAQ:UAE) is a $40m market cap ETF that covers businesses that are not only based in the UAE, but also those that have a majority of their operations in the UAE, or those that have economic exposure of over 10% in the UAE. These rather loose screens could likely result in a portfolio of stocks with broader exposure towards the Middle East region and not just the UAE.
There are also a couple of other facets that stand out. Firstly, concentration risk appears to be a dominant theme. The top 10 stocks account for nearly ~80% of the total portfolio, whilst the banking sector alone accounts for nearly half the portfolio.
Then this also appears to be an ETF that resorts to a high level of churn, so it may not quite be a suitable choice for those looking for a stable portfolio; the annual portfolio turnover rate works out to a whopping 112%. If I consider the other Middle East-based ETFs, covering regions such as Egypt, Qatar, Saudi, etc., the ETFs here have portfolio turnover rates that are considerably lower, within a range of 13% to 73%.
With oil prices trading over $100 a barrel during this month, investor interest in UAE is understandably quite high, particularly as OPEC+ does not look to be in any urgency to boost output beyond the 400,000 barrels a day production target. Whilst UAE has been prompted to do its bit to correct the demand/supply imbalance by some of its notable trade partners such as Japan, it does not appear as though that will be enough. Currently, it appears as though UAE and Saudi Arabia are the two key nations with meaningful spare capacity (source: Enverus Intelligence), and whilst the former may be tempted to renege its old stance, it does not appear as though the latter will do so. Also note that even if production were to increase, you can’t play down the impact of the loss of 3m barrels of oil a day from the Russian/Ukraine conflict, particularly when you consider that this alone accounts for 3% of the global daily consumption of oil. All in all, it looks as though prices could remain well ahead of what was initially forecasted at the start of the year
Most forecasting agencies were budgeting for oil at around $80-$90 a barrel for much of 2022; for instance, S&P Global was pointing to average Brent prices of $85 a barrel for the year. EIA now estimates that prices will likely average $113/b this month and hover around $112/b through Q2. At these prices, UAE’s GDP forecasts will likely be scaled up beyond the initial forecast of 2.6%, particularly when you consider that oil exports are by far the country’s largest source of exports.
It also looks as though things could be looking up for the banking sector of UAE (note that financials account for nearly half of UAE’s portfolio). As the dirham is pegged to the dollar, we could see the UAE central bank raise rates in line with the US Fed to prevent any speculation with the currency (admittedly the UAE is not compelled to raise rates given that inflation remains rather subdued). A country such as UAE with a high dependence on exports cannot afford to let its currency be subject to wild gyrations and this is what could happen if they don’t keep pace with US interest adjustments. Higher policy rates will likely reflect well on the net interest margins of UAE banks; S&P Global estimates that a 1% increase in rates could help boost the top 10 banks’ net income by 15% and ROAs by 1.4%.
I’d be interested to see how the UAE banks manage their capital allocation priorities this year. With oil prices where they are, asset quality risks could remain well contained, and I don’t see the need for these banks to be overly conservative with their buffers. Note that capital adequacy ratios of the top-10 banks (both tier 1 and the total capital adequacy ratio) remain well above the regulatory requirements and this could likely be deployed either via higher dividends (S&P Global thinks dividends could return to pre-pandemic levels this year) or further consolidation or even M&A beyond the UAE region. We’ve already seen some evidence of this; recent reports suggest that First Abu Dhabi Bank (22% weight in UAE ETF) is looking to acquire Egyptian-based- EFG Hermes, after having acquired Bank Audi’s Egyptian operations last year. More recently there have also been rumors suggesting that the bank was looking to acquire a smaller UAE rival – Abu Dhabi Commercial Bank to help boost its scale.

Capital Adequacy

S&P Global Ratings

S&P Global Ratings
Do note that hitherto, loan growth in UAE hasn’t been particularly robust and this has likely prompted the big banking players to deploy cash by picking up assets on the cheap, whilst waiting for the credit environment to pick up. If it hasn’t already, loan growth could potentially improve in the months ahead, particularly as we hit the weak base effect from March 2022.

Loan growth

Trading Economics

Trading Economics
When one considers UAE’s technicals and valuations, it’s fair to say that the picture looks quite mixed.
Technically, the stock has had a good solid run since the pandemic era lows, trending up in the shape of an ascending expanding broadening wedge pattern. One could perhaps argue that this uptrend looks overstretched to the upside (given the relative steepness of the trend) and could do with a pause. One also ought to consider that it has now reached a zone that served as an area of congestion for over two years from 2016 till mid-2018. Thus, at least technically, the risk-reward for a long position does not look great, and you may see this ETF consolidating within the current congestion zone. Alternatively, it may also pull back to the lower boundary of the wedge, closer to the $14 levels. If further upside were to come through, it would be difficult to see momentum beyond the $22 levels.

iShares MSCI UAE ETF

TradingView

TradingView
Even if you place UAE against the broader emerging market pack, as represented by the iShares CORE MSCI Emerging Markets ETF (IEMG), I don’t believe there’s any great edge in owning the former as it is now in the middle of its broad range.

UAE VS IEMG

StockCharts

StockCharts
As far as the valuations are concerned, I’ve compared UAE to four other middle-east based ETFs namely VanEck Vectors Egypt Index ETF (EGPT), iShares MSCI Qatar ETF (QAT), iShares MSCI Saudi Arabia ETF (KSA), and VanEck Vectors Israel ETF (ISRA).

Vals and yields

YCharts

YCharts
If one were to look at the forward P/E in isolation, clearly the UAE multiple of less than 10x is quite alluring, below the peer set average of 12x. But then again, look at the long-term earnings potential on offer; with the exception of ISRA, UAE falls short of all the other ETFs’ earnings profiles and is well below the peer set average of 16%.
What tilts things in UAE’s favor is the yield on offer; A plus 4% yield is miles ahead of what’s available in other Middle Eastern regions, and this is particularly striking when you consider that the ETF has already appreciated by 44% over the past year.
Clearly, there’s a lot to like about UAE, but the risk-reward from a technical viewpoint isn’t that great, and hence, I would be inclined to rate UAE as a HOLD, and only pursue a long position after we’ve seen a pullback in the ETF.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

source

Leave a Comment