At the same time, the economic and market recovery evident in the UAE over the past couple of years is soundly based on strong fundamental drivers such as planned infrastructure expenditure, growing tourist arrivals and demand for real estate, none of which has any connection with Iraq. Importantly, the region is also now looking a lot stronger than it was in the boom years of 2004-2007, with much less leverage and market valuations showing much greater discernment between assets.
And current valuations do not appear excessive. In the key financials sector, banks are currently trading at around one and a half times their book value, having been valued below book value last year before the market surged higher. But the same banks are generating a return on equity as high as 20%, are likely to grow their earnings by at least 10% per annum for the foreseeable future and are paying out a 5% dividend yield to shareholders. In this context, their shares look far from expensive and appear appropriately valued; valuations have certainly been significantly higher than they are now in the past.
The Second Trigger: Arabtec 
The recent run-up in the overall market in Dubai, and its subsequent setback, mirrors the roller coaster ride endured by shares in Arabtec, albeit with less intensity. Arabtec had more than quadrupled in value over the past 12 months as a new chief executive announced plans to expand into areas including oil and gas, infrastructure and power and the company agreed to build 1 million homes for low-income families in Egypt, a contract worth around USD 40 billion, all with the implicit backing of the state. These developments prompted many local investors to buy the shares, often on borrowed money, with the upgrading of the UAE to emerging market status under the MSCI classification an additional attraction.
The Arabtec share price clearly lost touch with economic reality as a result. Rumours that an Abu Dhabi government vehicle that had owned 22% of Arabtec was reducing its stake, subsequently confirmed, coupled with the resignation of the chief executive amidst further rumours of a wholesale management clear-out, fuelled by silence from the company, sent shares in Arabtec tumbling in early June and by the end of the month they had lost around two-thirds of their value. From here it will be difficult for Arabtec to regain the confidence of investors, and management changes could affect the company’s ability to finish its backlog of projects, with execution is the most critical part of the contracting business. Its current share price, still some 30% higher than its end 2013 value despite the recent collapse, seems closer to a rational valuation but remains subject to a high degree of uncertainty.
Although the Arabtec trigger can be seen simply as a valuation mistake that has now been righted, the importance of this one stock to the Dubai Financial Market and the governance concerns that this episode raise may mean that the fundamentally sound medium-term prospects for the local economy may not be fully reflected in local share price valuations over the short term.
Akhilesh Baveja, Portfolio Advisor, Magna MENA Fund
