Four years ago, I wrote an article calling the peak in the investment cycle in the consumer sector. Today, I am calling the end of the prolonged downturn we have been in since oil prices peaked in 2014.
The broader economic indicators are already signaling a rebound. This can be seen in the purchasing managers indices, as well as in the foreign direct investment (FDI), which was up by 126% in the Kingdom of Saudi Arabia (KSA) in 2018. In the capital markets, the massive oversubscription of the international bond issues of the KSA government and of Saudi Aramco is also a sign of investors’ confidence in the region increasing.
In terms of our own data at Awad Capital, our clients are reporting “marginal improvements” in demand for their products and services in 2019 so far, on a like-for-like basis relative to last year. These are clients in the food and beverage sectors, diversified retail, and the broader consumer sector. The acid test will once again be the summer, and the religious holidays in terms of their impact on consumption.
This year will be the first one in a while where Eid Al Fitr finished during the school year, with consumers in the UAE going back to the country for a few weeks before the summer holidays officially kicked off. On the other side of the summer, Eid El Adha will fall in August instead of September, hence juxtaposing summer holidays and Eid holidays, and bringing the consumers back home a few days or even weeks earlier. The cumulative effect of these two seasonal factors will be, in my view, supportive of local demand, and dampen the negative effect of the holidays on business activity.
Our forecast is that the real turnaround will start to be seen in the numbers in Q4 2019- read on for more on why we expect this to happen.
No news is good news
The difficult years we saw since 2015 were not induced by external factors, such as was the case in the great financial crisis of 2008. Indeed, these were the result of mostly local and regional factors, in addition to the oil prices fluctuations, which are always the biggest drivers of our regional economies. Just a look at the events which had a negative effect on the regional economies puts into perspective how idiosyncratic this recent slowdown has been:
The fall in oil prices
It all started in the second half of 2014 when oil fell from a peak of US$115 per barrel in June 2014, to under $35 at the end of February 2016. It then stayed between $45 and $55 for a year. Since 2017, we have seen the oil price trending higher, reaching an average of $65 in 2018, versus an average of $50 in 2017. It is now forecasted to be stable between $55 and $65 in 2019 and to average $63.
The war in Syria and Iraq
The war in Syria started in 2011, and reached its most extreme point in 2016, with it now thought to be in its final stages. Much like was the case with Iraq, the economic impact of this war should not be underestimated. Syria and Iraq are substantial markets with 56 million consumers. These consumers were rising, and these countries have the potential to be great markets for GCC exporters as well as trading partners. The reconstruction of Syria and Iraq opens great avenues for companies across the region.
Introduction of VAT
While this was a long-awaited and expected move, it’s timing further hit the consumer, and retailers’ margins. More than a year on, VAT is now part of everyday life, and its financing of the government budgets should benefit the broader economy at some stage.
The expat tax
In 2017, KSA introduced a series of measures to further boost Saudization by both reducing expatriate employment and encouraging local employment. These objectives are absolutely sound in the long-term. However, the economy has had to adjust to the new measures in the short term. With regard to the “tax on expatriates,” it has had a number of negative implications:
– The actual tax reduces the liquidity available for spending by companies and the expatriate employees
– Many expats and their employers are not able to cope with the tax, hence resulting in an exodus of expatriates returning to their countries, and hence reducing the pool of local consumers
– In certain cases, a solution has been for the expat bread earner to stay in KSA, while sending their taxed dependents back home. This has the unintended effect of reducing the number of consumers in the country, while not always creating new job openings for Saudi nationals.
While the above list may seem gloomy and more could be added to it, its purpose is to explain the slowdown that we have seen in consumer-related businesses. The positive news, however, is that we do not see any further bad news on the horizon. Indeed, some of the reform measures should be starting to bear positive fruits on the economy, while the oil price is stabilizing, and the global economy remains broadly stable.
THE FUNDAMENTALS ARE AS GOOD AS EVER (AND ECONOMIC REFORM IS STARTING TO BEAR ITS FRUITS)
When it comes to the positive fundamentals of our region, these can be listed, in short, as follows:
– Vast natural resources
– Strategic geographic location
– Young and growing populations
– Increasing levels of wealth
– First-class infrastructure
None of these factors have gone away. Together, they combine to making this region a very attractive destination for investment. To this list, we can now add: accelerating economic reform.
There is a very broad economic reform on- going across our region. I have listed here a far from exhaustive list of some of the most remarkable measures the governments are taking to modernize and boost their economies. These are some of the many fundamental drivers of the expected economic recovery:
At its heart, Saudi Arabia’s Vision 2030 is a series of reforms designed to diversify the country’s economy, reducing its overall reliance on oil. The plans are based on three pillars, acknowledging Saudi Arabia’s role at the heart of the Islamic world, its ability to become a global investment powerhouse, and finally, positioning itself as a global hub connecting Africa, Asia, and Europe. As part of its diversification plans, Saudi Arabia is investing into key sectors such as culture, entertainment, and sports, as well as introducing reforms to improve its business climate. 80 projects are said to be planned for completion by 2030, including a luxury Red Sea resort featuring 50 islands, covering 34,000 sq. km., and a $2 billion investment into the General Authority for Entertainment, the body responsible for leisure initiatives across the country. Already in 2018, foreign investments have made more than a two-fold increase from the previous year.
KSA privatization program
In April of last year, Saudi Arabia announced its privatization program, which aims to pull in $11 billion worth of non-oil revenues by 2020, creating up to 12,000 jobs. Focused on driving public-private partnership investments worth between SAR24–28 billion, plans include the corporatization and privatization of key government services such as transport, manufacturing and water. The government aims to raise $200 billion through privatization in the coming years as part of its Vision 2030. It is hoped through its privatization reforms that the Saudi government will improve services, reduce government spending and enable it to focus on ensuring the legislative and regulatory environment to enable businesses to thrive. At the same time, various transparency and anti-corruption reforms in Saudi Arabia have been moving at a fast pace, and with significant high-level support. This is key for encouraging entrepreneurship as well as foreign investment, and a healthy development of competition within the private sector.
KSA and UAE allowing foreign ownership
In an effort to attract more FDI to their nations, both KSA and UAE have introduced reforms permitting 100% foreign ownership in multiple sectors. The reforms are not only designed to draw more investments into each country, but among multiple benefits to businesses, it is thought that it will drive M&A activity and FDI due to the greater pool of foreign purchasers.
UAE and KSA giving long term visas
The UAE has recently undertaken a sweeping set of reforms in relation to visa requirements, which have been designed to help facilitate the process for people seeking employment. These reforms have included providing a one-year grace period for widows and divorced women, students completing university, and the possibility of a two-time renewal of 30-day visit visa. This has been followed up with the introduction of a 10-year visa for highly skilled workers and investors, and this is expected to improve all round confidence among the business community and investors in committing to the UAE market. Similarly, KSA has been relaxing its visa rules, and both countries are talking of offering long term or even permanent residencies.
UAE and KSA bankruptcy laws
Both countries have introduced upgraded bankruptcy laws. By introducing such legislation, they hope to encourage entrepreneurship and protect investors by providing a more robust legal framework for businesses. The law was first implemented in the UAE in a case in 2018, enabling a company to restructure its debt, and then reassume business operations.
Expo 2020 Dubai
While we cannot tell for sure if no more bad news will come our way in the future, one piece of good news is about to become a reality in Dubai. Having been a catchword for more than five years, Expo 2020 will be a reality from October 20, 2020 to April 10, 2021, bringing 25 million visitors to the UAE, with an estimated $23.4 billion to be added to the UAE’s GDP. Beyond the numbers, Expo 2020 will be a big boost to both consumers’ and investors’ confidence in the region. It will also have a permanent impact on the global positioning of Dubai as a tourism and events destination, further fueling the growth of the tourism, hospitality, transport, and food and beverage segments of the economy for many years to come. Indeed, the legacy of Expo will be long lasting, and we will see Dubai hosting even more high-profile global events, including even potentially the Olympics.
I am confident that domestic factors are now lined up for an upturn. Actually, the sheer unanimous pessimism I encounter in the local business community is in itself a sign that we are hitting the bottom. However, one thing can still dip us back into negative territory, and that would be an international recession, which could be for example driven by an escalation of the trade wars, or another US-driven credit crisis, this time originating in student loans or credit cards.
A NEW NORMAL IN THE GCC
The main sectors this article focuses on are the consumer-facing sectors such as retail, healthcare, education, and food and beverage. These are the sectors which used to be cherished by investors, and about which I warned in my 2015 article. However, a word of caution: we do not expect to revisit the growth levels seen in the years preceding this recent slowdown.
Our markets -and my focus is mostly on UAE and KSA- have significantly matured over the last 10 years. Particularly in Dubai, the level of competition for consumer’s attention has reached levels similar to those of developed markets. In parallel, we have seen the massive disruption of e-commerce, as well as a slowdown or retrenchment in expat immigration. The consequence of this new normal is that, while growth will resume, it will be at lower levels.
So, expect low to mid-single digits, where previously double digits were the norm. Also expect lower margins, more in line with international peers. KSA probably has more growth and margin still under its belt given the scale of the economy and the abundance of opportunities, but this new normal will also catch up in the Kingdom.
The implication for operators and investors is as follows: to survive and thrive, consumer-facing businesses need to be managed much more professionally and tightly than they were in the past. And in order to be consistently profitable at razor-thin margins, scale will be key, leaving little room for small and marginal operators. The winner in this will hopefully be the consumer, who will be able to enjoy better products and services at lower prices.
August 20, 2019
CEO at Awad Capital