|By Matein Khalid| The fall in oil prices since 2014 has triggered a liquidity crunch and higher funding costs in the UAE banking system. EIBOR is almost double the London interbank rate LIBOR. Non-performing loan (NPL) have begun to rise as property prices have fallen 20% from their peak and corporate/SME borrowers are hit by a sharp downturn in the business cycle. DIB shares reflect these macro realities, down from their 52 week high of 7 AED to only 5.25 as I write. Yet as a financial market strategist, I learn to discount the future, not extrapolate the past, to avoid being Oscar Wilde’s man who knows the price of everything and the value of nothing. I believe DIB offers compelling value, ideally at 5 AED. Why?
One, as Dubai’s oldest, biggest Sharia compliant lender, DIB is the most liquid Islamic bank in the UAE, particularly after its recent, highly successful (3 times oversubscribed) rights issue. The rights issue has boosted DIB’s capital adequacy ratio from 15.6% to 18%. DIB has $46 billion in assets, one third of those dominant Dubai lender Emirates NBD, which has $116 billion in assets. The rights issue thus positions DIB with excess capital that it can deploy to earn high margin returns.
Two, some banks in the UAE trade at stratospheric valuations in the stock market. For instance, Ajman Bank trades at 17 times earnings. Not DIB. DIB trades trades at 7.8 times forward earnings and 1.2 times book value. It offers a 7% cash dividend. These are deep value metrics I cannot ignore.
Three, management has guided a 17 to 18% projected range for DIB’s return on equity next year, a clear indicator that its post 2013 management, led by CEO Adnan Chilwan, can generate share value via borrowings in the sukuk market and equity capital issuance. There is no risk to the cash dividend if DIB achieves these targets. A bank with a 18% ROE and 2.3% return on assets should command a valuation rerating on DFM.
Four, DIB has increasingly morphed from a UAE lender to a international consumer and corporate bank. DIB has just entered the Kenyan banking market after its acquisition of the Imperial Bank in Nairobi, thus enabling it to broaden its African trade finance offering at a time Dubai emerges as the trade entrepot for East and West Africa. DIB has acquired 40% of Bank Panin in Indonesia, the world’s most populous Muslim nation and the largest economy in ASEAN. DIB has expanded in Pakistan under the leadership of its country CEO, my old friend and ex colleague. Junaid Ahmed. DIB’s international diversification boosts its profitability momentum and reduces its dependence on the volatile consumer credit and property market cycle that gutted the bank’s shares in 2008-9.
Five, based on current trends and the first half earnings report, the net profit of DIB could be AED 3700 million or $1 billion, a stellar milestone in the evolution of the bank that will not go unnoticed by global and GCC institutional investors.
Six, at a time of dismal loan growth in the UAE banking system, DIB has delivered double digit growth in net??? Islamic financing. Its implied cost of risk is among the lowest in UAE banking though I expect impairments in consumer, corporate and property loan portfolios to rise in 2017.
Seven, funding stress means that a dozen commercial banks in the UAE have loan/deposit ratios that are higher than 100%. This is not the case with DIB, whose advances/deposit ratio is 93%.
Eight, the bank has an exceptionally low cost to income ratio at 34%. This ratio is 55 – 60% for US money center banks such as Citigroup and J.P. Morgan.
Nine, I track trends in UAE bank return on equity (ROE) overtime as a proxy for shareholder value creation. Many UAE retail bank ROE ratios have fallen in the past decade. DIB’s return on equity rose from 13% in 2012 to 22% last year. This bank has become more profitable over time even though its net impaired assets are only 2.9%. DIB just won the coveted co-lead management rule for Pakistan’s sovereign sukuk. The bank’s trade finance, guarantee and syndicated loan fee income in on a roll. DIB’s new rights issue means it can expand its increasingly global asset book without pressure on its funding costs. This is unique in the current zeitgeist of UAE banking.
Currencies – The short sterling idea remains a winner!
Hard Brexit has proved fabulously profitable for my tribe of sterling bears since the Tory conference in Birmingham. Sterling is 1.2160 as I write and sterling volatility in the foreign exchange options market has risen to 12.50, more than the Turkish lira. Sterling has now lost 18% of its value against the dollar in 2016 alone, saddling GCC investors with untold billions in losses on their holdings of London/UK property. A sterling crash on this scale means inflation will rise far above the 3% level implied in the gilt market breakevens. This means the Bank of England will be forced to do a policy U-turn or intervene in the currency markets in an attempt to smooth the sterling’s free fall.
While extreme short positioning makes me nervous and I would book profits on the 1.33 sterling short recommended in this column after the June 24 referendum, the trend for sterling remains lower, significantly lower. Sterling rallies will be short lived and opportunities will emerge to short the currency of a nation with a 7% current account deficit, higher oil imports and untenable easy money central bank policies. As I wrote here in July, my strategic target is 1.05 against the US dollar.
The Mexican peso has fallen 9% against the US dollar in 2016, a victim of Donald Trump’s threats to deport millions of Mexican immigrants from the US, build a wall across the Rio Grande, revoke NAFTA and halt the “offshoring” of US factories across the border. The Mexican peso is the most liquid currency in emerging markets and is often a cheap hedge for macro funds at a time of risk aversion. This was the reason the Mexican peso tanked 4% in the week after Brexit this summer. There is a pipeline of future shocks even if Trump loses the election – China, Article 50, the Italian referendum, the US Senate and House elections. Despite the Banco de Mexico’s rate rise, the peso could well test 20.
China’s shocking fall in exports despite a lower yuan suggests that Beijing’s tsunami of money creation has only lead to history’s greatest credit bubble, as the People’s Republic has accumulated a 245 debt/GDP ratio. There is no way President Xi and his Politburo can deliver the 6.5% GDP growth target, cool the property market and provide an easy money lifeline to its state owned corporate colossi without a further, significant depreciation of the Chinese yuan. This is the lowest political cost option for the Red Emperors in Beijing at a time when half the Politburo Standing Committee is scheduled to retire. I believe the Chinese yuan can well fall to 7.4% in the next six to eight months. The yuan depreciation unnerve global markets, as it did in August 2015.
The Euro has fallen victim to political angst about Brexit, the Italian referendum and banking woes, Deutsche Bank’s multiple disasters, the challenge to Chancellor Merkel from right wing populists in the AFD and the increasing impotence of the ECB/Bundesbank to revive growth by money printing alone. The Euro’s bearish momentum will accelerate and I expect it to fall to 1.0920.
King Dollar has taken the Japanese yen down to 104, not a Bank of Japan that has run out of monetary ammunition. Yet a risk aversion spasm in global risk asset will trigger a Pavlovian scramble to buy the safe haven yen. It would not surprise me to continue to see the Japanese yen appreciate, possibly to as high as 96 against the US dollar by next June. The failure of Abenomics to structurally reform Japan Inc. leaves no other credible scenario for the Empire of the Rising Sun!
Gold has plummeted to $1250 due to King Dollar, hawkish Fed comments and the rise in US Treasury bond yields. However, as long as the June 7 low at $1235 is not violated, I would accumulate gold as a hedge against rising systemic risk in global banking, the rise of inflation as Western governments use fiscal stimulus to reflate moribund economies and a new Cold War between the US and Russia. I expect gold to test and break through the $1277 October 5 high on its path to $1300 an ounce.
Despite $52 Brent, the Canadian dollar is weak at 1.32. Yet US jobless claims are at 43 year lows while Canada has lost 73,000 jobs in the past three months. The Fed will raise rates while Ottawa could well cut rates to avoid recession. O Canada, loonie tanks to 1.40 even if Trump loses?
Market View – What next for Aerospace and defense shares?
Commercial aerospace is no longer the valuation darling of Wall Street – with good reason. Oil prices have risen 65% from their February lows. The Federal Reserve will raise interest rates and tighten liquidity in the bank aircraft finance market. The surge in King Dollar has dampened passenger air traffic growth. The AirAsia crash has hit budget travel in Southeast Asia. Civil wars in the Arab world, Russian military interventions in Syria and Ukraine, the Turkish coup attempt, China’s 25 year lows in economic growth and Brexit have all hit cross border tourism. The IMF has slashed global growth forecasts to 2.5% from 3.2%. Airlines have begun to defer orders for wide bodied planes. The aerospace sector has been derated on Wall Street as storm clouds darken its macroeconomic and earnings growth outlook. Honeywell’s recent 10% share plunge is a dark omen.
Boeing at $133 is overvalued if the commercial aircraft cycle has peaked, as I expect it has. Boeing Commercial Aircraft (BCA) faces its first cyclical downturn since the 2008-9 global recession. CEO Dennis Muilenburg warned the Street to expect “flattish” revenues in both commercial and defense in 2017. This means soft 777 orders will reduce the production run rate while 787 Dreamliner deliveries have been flat in the past year. Aggressive pricing on the 737 MAX will not help operating margins though I expect free cash flow growth per share can rise by at least 10% in the next five years. The latest lewd Trump videos mean Hilary Clinton wins the White House on November 8. This means no aggressive ramp up in Pentagon military business or boost to Boeing’s military aircraft businesses (e.g. F-15’s, Apache helicopters, F-18’s, Starlifter transport planes etc.), almost 48% of total revenue.
Near term production pressures do not negate the strength of Boeing’s 5700 order backlog, the scale of US/Europe replacement demand and the emerging market air travel growth potential. While US fiscal pressures will hit specific programs, such as the C-17 closure, Boeing is one of the world’s top military hardware vendors at a time when Washington confronts Russia in the Middle East and China in the Pacific Basin. The recent sales of F-15 fighter sales to Qatar and Israel and F-18 sales to Kuwait demonstrate Boeing’s military prowess. I expect Boeing shares to trade in a 120 – 150 range in the next twelve months.
Raytheon (RTN) is the world’s preeminent supplier of air defense system (the Patriot missiles that confronted Saddam’s Sands in the first Gulf War), air to air missiles, radars, sensors and communications equipment to the Pentagon, NATO and Uncle Sam allied air forces all over the world.
After some botched acquisitions in the late 1990’s, Raytheon has almost doubled its operating margins to 13% in the past decade and has spent a staggering $5 billion in share buybacks since 2012. Raytheon shares were a fabulous winner on Wall Street, up 26% in 2016 and though low oil prices did not hit its Middle East sales as regional defense budgets did not slash spending on national security hardware. Apart from Lockheed, no other company in the world can match Raytheon’s technology based global missiles sales momentum. However, after a stellar 2016, I would book profits in Raytheon at $140 a share.
Honeywell blamed a weak aerospace cycle when it guided down its estimates to $6.60, the reason its shares tanked last Friday to $105 a share. The firm now trades at a valuation discount to its peers at 15 times earnings, I expect downside on the preannouncement and the industrial conglomerate’s project execution woes. Honeywell’s $15 billion aerospace business is a classic barometer of demands since it produces everything from cockpit “nose to tail” instruments to landing gear. I would stay short Honeywell for a $98 target.
The resignation of Wells Fargo CEO John Stumpf was inevitable after the sordid cross selling scandal has devastated the shares of the Californian megabank, once the most valuable bank on the planet. While optically attractive after their fall from 56 to 45, I am afraid to buy the shares because, unlike J.P. Morgan’s London Whale or Goldman’s Abacus scandal, the victims here are not institutions but millions of Mom and Pop all-American voters in an election year. Litigation risk will be a sword of Damocles on Wells Fargo shares.
