Matein Khalid explores why the Dubai developer is a sound investment
The 20 per cent-plus fall in the DFM index in June was triggered by the ghastly 70 per cent plunge in Arabtec that raises fundamental questions about corporate governance, disclosure, wild rumours and market manipulation. This is all the more serious since US interest rates are on the brink of a major rise while the IMF and UAE Central Bank have both publicly warned investors about a local property bubble. The DFM is one of the world's most heavily-weighted property, banking and construction indices, with Arabtec alone the fifth-heaviest weighted constituent on the DFM.
The parabolic bubble bust cycle in Arabtec shares in 2014 demonstrates that speculative manias always end in tears. Arabtec's free-fall has gutted the net asset value of UAE mutual funds. The resignation of Hassen Ismaik as CEO, the firings of top corporate executives and the fate of his shareholding stake are all major sources of future uncertainty and systemic risk. Iraq, the holy month of Ramadan, thin trading volumes, second-quarter results and high valuations all argue against a sustained uptrend this summer. The proverbial Victorian surgeon's motto dominates, when in doubt, cut it out! During time of high market risk, I focus on only the largest, most illiquid, most blue chip shares available. In the DFM, this means Emaar Properties. I believe Emaar offers compelling value at Dh8, a level we briefly almost hit in June. Why?
At Dh8, Emaar would trade at 16 times forward metrics, since 0.50 EPS in 2015 is credible. This level also implies a dividend yield near 2.6 per cent. These metrics are surely attractive for the largest, best managed property developer in the Middle East that is on the precipice of a historic corporate transformation due to the planned spinoff of its malls and retail business. Even a 25 per cent stake flotation means Emaar will now be viewed by international investors as not just a property developer but a de facto high-dividend real estate investment trust, or Reit.
Dubai's project pipeline and its demographics, tourist and economic growth trends make Emaar's property/hospitality segments a growth business that justifies a 16 times forward valuation. This is the reason my "value zone" in Emaar is Dh8. Since I was strongly bullish on Emaar at levels just above Dh3 in late-2012/early-2013, this "value zone" is extremely critical to evaluate my risk reward calculus.
Based on my prior experience investing in Reits, Emaar's leasing businesses can be valued at a 15-16 times valuation multiple as long as dollar interest rates do not spike or Gulf equities do not tank, two macro scenarios whose risk cannot be glossed over. Emaar's land bank is primarily in the UAE but also in Turkey and Egypt. This means its property development and hospitality business has a low valuation at 1.3 times book value. I am worried about Egypt's sovereign solvency risk if the new government does not cut food/fuel subsidies or pay back the $6 billion owned to international oil and gas producers. I am even more worried about Turkey's seven per cent current account deficit, dependence on offshore hot money to stabilise the lira, leveraged banking system and social unrest if Erdogan reconfigures Ankara politics into a de Gaulle-style presidential system.
The mall and leasing business IPO will be a game-changer for Emaar, since it could well raise $2.5 billion and the promise of a special dividend payout for shareholders. My take? Ahlan wa sahlan, Mr Special Dividend!
The Emaar Mall IPO will be a historic event in the DFM and the UAE capital markets this autumn. It offers investors stable revenues, high operating margin, low capex and thus a tsunami of free cash flow. The Dubai Mall, with its 76 million visitors, is a crown jewel and trophy asset for Dubai Inc, with retail 20 per cent of the emirate's GDP. The Dubai Mall, Marina Mall (100 per cent occupancy ratios) and Gold and Diamond Park will contribute 80 per cent of Emaar's leasing assets, with 20-year anchor tenant leases and the prospect of capacity addition.
Dividend growth and a higher RoE in leasing will then support my expectation of a valuation rerating in Emaar, though most of the easy money has been made since my late-2012/early-2013 call. Downtown Dubai and Mohammed bin Rashid City could be the next growth engines for Emaar. If Tom Cruise sought his highway to danger zone, I prefer to buy Emaar in my highway to the value zone.
Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at firstname.lastname@example.org