Amwal Investment Outlook
May 2014

Differing prospects for Qatari companies beyond 2022

Stock market investing can be very rewarding if done right, but consistent investment returns require a correct assessment of the long-term prospects of the companies one invests in.

This can however be a challenging task in a market like Qatar which is a relatively young economy and has a very large investment budget for the next several years in the run up to 2022. Yet the prospects in particular for the non-energy economy after 2022 are relatively unknown.

When investing in a stock, we are effectively investing in the present value of the company's entire future stream of earnings. Hence, if a company will be making materially different profits after the next eight years, its value will be quite different from that of another company which will not experience such a fundamental change in the attractiveness of the industry it operates in.

P/E valuations can be misleading

This makes valuing a company using P/E a misleading effort. In a normal growth market/industry, P/E could be a useful benchmark, but when earnings are expected to change rapidly, this could be very misleading.

The main purpose of this report is to share with our investors our thinking on the future prospects of companies and the kind of analysis we conduct when selecting stocks for client portfolios.

From the perspective of their profitability outlook, Qatari stocks can be grouped into four categories:

  • First are exporters like Industries Qatar and Mesaieed Petrochemical which export the bulk of their output (chemicals). Such businesses are in a way immune from what happens to the local economy after 2022 (assuming the feedstock subsidies do not change). We would value these companies similar to any other global business from this point of view.
  • Second are businesses like building materials producers, whose business model is mainly focused on catering to the infrastructure investments being made in the country. These companies should make good profits between now until completion of the infrastructure build out. If we assume investments will be completed a year before 2022, we have about 8 potential years of strong profitability. But as there could be much less demand for building materials after that, and it will be difficult to redeploy the assets to some other use, the value of assets could be worth much less, unless their export-competitiveness is high. For some building materials such as cement, exporting to long distances is costly and not economically feasible.
  • Third are industries such as real estate, consumer and telecom, whose prospects largely depend on domestic population. They therefore also get a boost from the infrastructure build out from the additional population in Qatar working for these projects. The future profitability of these industries are dependent on how much will the population be remaining after the build out phase. Recent conversations with management teams of certain companies in these sectors, corroborate our view that the strategic thinking of such businesses should factor in potentially two very different phases of growth.
  • Finally we have banks, which lend to all of the above but all of their assets are easily movable (cash), and hence need to be treated differently. A bank can redeploy its assets into other markets, make acquisitions or pay it back to investors. So while banks' profitability may be also affected after 2022, they will likely be the least affected. It is important to note however, that not all banks will do equally well, as the management decisions in the use of the capital accumulated will have an important bearing on long term value.

While eight years seems long enough, those who are familiar with net present value (NPV) calculations will know that it does make up a significant portion of a company's value. Further, the NPV impact of post-2022 earnings becomes more important with each passing year. We believe the equity market could start pricing this within the next 3-4 years.

To give an example, a company with very good earnings prospects for the next 8 years, but less than half of prior year earnings will be valued at around 50% discount to a company with stable earnings prospects.

While many investors believe short term earnings are more important to stock valuation, our extensive back-testing guides us to focus on long term earnings as the key driver of stock returns in the long term.

In our investment research for stock selection, we regularly review our forecasts for each company's future profitability and select those that offer the best upside, taking into account their earnings prospects up to and beyond 2022.