The Arabian Markets - Rebuilding the Economy

Nomura Asset Management U.K. Limited Dubai branch April 19th, 2021
Tarek Fadlallah, CFA
Chief Executive Officer
Nomura Asset Management
Middle East
P.O. Box 506882
Dubai, UAE
Tel: +971 4 428 4587
www.nomura-asset.co.uk
April 19th, 2021
The Arabian Markets
Highlights:
 Governments have inadvertently
created a huge dependency
problem which is unravelling, as
entitlements that sustained
unviable firms are withdrawn, and
regulations are rolled back.
 Shareholders that profited from
the social contract but barely
reinvested in expansion and in-
novation and maximized dividend
payouts are vulnerable to demise.
 The GCC can prosper if the
private sector is healthy, strong
and can wean itself off the
outdated social contract in favour
of a New Deal that incentivizes
innovation and investment,
instead of dependency.
 Rather than funding wasteful
subsidies they should offer firms
incentives to modernize and
transition away from antiquated
operations by rewarding positive,
rather than negative, behaviour.
Content:
Economy & Markets 2
Economic Thesis 3
Profitless Growth 4
Value Destruction 5
Death by Stealth 6
Climate Economics 7
Bottom Line 8
Market Commentary — a product of Sales and Marketing and not Investment Research or Advice
Nomura Asset Management U.K. Limited Dubai branch is regulated by the Dubai Financial Services Authority
Rebuilding the Economy

Page 2
Economy & Markets
There was plenty of bad news last year, but one bright spot was the relative resilience of GCC economies
under the most challenging circumstances, with the collapse in demand for oil adding to other woes.
Governments succeeded in limiting the decline in economic activity by containing the pandemic and
avoiding the prolonged lockdowns that were forced upon other countries.
Stock markets in Saudi Arabia and Abu Dhabi in particular have enjoyed a stellar start to the year.
The pivotal moment in Saudi Arabia came when the PIF, which had been flexing its muscles in the global
stock markets, signaled its intent to increase domestic investments and the central bank injected liquidity.
However, not everyone was able to extend sufficient fiscal support with Dubai constrained by the massive
blow to its travel, tourism, retail, property and hospitality sectors — a quintuple whammy.
Fortunately, the doom and gloom expressed in a Dubai Chamber of Commerce SME survey last May did
not materialise due to a slew of extraordinary reforms and the resolve to keep the economy open.
A different story for its stock market which continued to deliver
poor returns and alarming corporate developments — e.g. the
delisting of Arabtec and the cancellation of the Tristar IPO.
Emaar Malls being bought back by Emaar Properties at a steep
discount to its IPO price also left investors with a sour taste.
The IMF sees a decent, if unspectacular, rebound in Dubai and the UAE more generally, assigning a 3.1%
GDP forecast for this year and 2.6% next year — well below the 4.6% achieved between 2000-2017.
It also highlighted the need for investment in technology as a critical component of economic development
across MENA, but current contribution to GDP and stock markets is tiny. Billions need to be committed.
There is a more optimistic scenario for the regional economies if the public and private sectors can unite
in renewed common purpose — and early examples for how this is already working.
Dubai and the UAE have set the standards for diversification but opportunities emerging is Saudi domestic
tourism and hospitality were hardly imagined two years ago, and the conditions for renewable energy in
the region can make it an important global hub.
But for these opportunities to be fully developed and to have a meaningful impact on the overall economic
trajectory there are difficult legacy issues in the public and private sectors that need to be addressed.
Source: Bloomberg
Source: IMF, April 2021
2000-17 2018 2019 2020 2021e 2022e
Saudi Arabia 3.7 2.4 0.3 -4.1 2.9 4.0
UAE 4.6 1.2 1.7 -5.9 3.1 2.6
Kuwait 3.9 1.2 0.4 -8.1 0.7 3.2
MENA 4.5 1.2 0.8 -3.4 4.0 3.7

Page 3
Economic Thesis
To find the destination, we need to frame the GCC’s economic journey in the context of its history, the
role of oil revenues and the social contract between governments and the private sector.
At its core, the social contract allowed businesses to prosper and profit in basically three ways:
1. Government off-take through ministries, their surrogates and state-owned enterprises, to guarantee
demand for products, such as steel, cement, construction materials, equipment, machinery and so on.
2. Sole agencies and exclusive local distributers that benefited largely from the innovation, manufacturing
and marketing by international companies and global brands.
3. Subsidies for utilities, transportation, foodstuffs and feedstock that let domestic companies compete
on unequal terms with importers, and produced largely contrived profit margins.
In the case of Saudi Arabia, a sizeable chunk of the wealth created was invested overseas and is estimated,
by respected private banking and consultant surveys, at up to $1 trillion (around 130% of GDP).
Oil revenues meanwhile helped diversify the economy but slowly, with oil as a percentage of GDP still too
high and accounting for about two-thirds of budget revenues in Saudi Arabia.
The paradox of plenty holds that no natural-resource dependent economy has ever transitioned quickly,
smoothly and without upheaval — the stakes are therefore incredibly high and the task facing the GCC,
especially the Saudi economy by virtue of its size, is literally un-pre-ce-den-ted (hyphens intended).
There is an onus on the Saudi non-oil
economy to grow rapidly to offset the
low expected growth in the oil sector.
The non-oil economy needs to grow at
up to 8% per year — higher than in its
history, and beyond any forecast.
In its golden age, when the government
ran huge budget surpluses and poured
money into the economy, non-oil GDP
reached 6% but 2012 was the last year
in which this level was achieved.
The IMF recently warned about the depletion of sovereign reserves and the need for heavy borrowing.
Not an institution known for scaremongering, its forecasts were sobering.
There is no existential crisis but there are scenarios that might take us close to the brink, so better to plan
accordingly, even if the likelihood seems remote — companies can take these risks; countries can not!
Amid such peril it might be reasonable for governments to commandeer national resources to confront
these grave risks. Saudi Arabia has not gone that far (and perhaps it should?) but is embracing a whole
range of ambitious market-driven initiatives to implement its industrial policy.
2.47%
4.33%
$0
$20
$40
$60
$80
$100
$120
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
03/2011 07/2012 11/2013 03/2015 07/2016 11/2017 03/2019 07/2020
Saudi Non-Oil GDP YoY (constant prices) vs WTI Oil (rh scale)
Source: Saudi Arabian Central Department of Statistics, Bloomberg, Nomura Asset Management
6.26%
Average
2.75%
Average

Page 4
Profitless Growth
Since 2005 the GCC economy has expanded by around 140%, making it nearly two and a half times bigger
so it’s reasonable to assume that profits should have increased significantly, except that they haven’t — at
least not those at the non-financial corporations listed on the regional stock markets.
Data compiled by Marmore Research for just under 600 listed companies show that corporate profits,
excluding the banks and Saudi Aramco, have been essentially flat for the past fifteen years.
The combined profits of these companies
was $26.7 billion in 2005 and is expected
to be around $24 billion this year as the
region recovers from the pandemic. This
represents a decline of 10% in nominal
dollars, unadjusted for inflation.
Profits seem to swing in tandem with oil
prices and peak profits of $37.7 billion in
2014 followed a period of record prices.
This tell-tale correlation confirms the
dependence of the ostensibly non-oil
economy on oil, and serves as a reminder
for why diversification is challenging.
The decline in profits across the corporate sector is mainly due to cuts in subsidies, higher taxation,
elevated operating costs, deregulation and growing competition.
These factors did not materially affect the
banking sector which increased its profits.
Indeed bank earnings between 2005 and 2019
nearly tripled before falling back last year.
Banks have held on to their own version of the
social contract, with governments feeding them
cheap sovereign deposits and central banks
offering regulatory protection.
The variations, inequity and unpredictability of
profits have exposed deep-rooted systemic
inefficiencies that need to be addressed.
Governments have inadvertently created a huge dependency problem which is unravelling, as entitlements
that sustained unviable firms are withdrawn, and regulations are rolled back.
Businesses addicted to public spending or government generosity will find it difficult to satisfy investors and
will eventually lose access to capital, even from the deepest pockets.
The gulf between companies that adapt, and those that persist with their outdated strategies, will become
more evident and give rise to opportunities for active managers in the stock markets.
$0
$20
$40
$60
$80
$100
$120
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
2005 2007 2009 2011 2013 2015 2017 2019 2021
GCC Corporate Profits (excluding Banks/Aramco)
Brent Oil Corporate Profits
Source: Marmore Research, Bloomberg, Nomura Asset Management
(million)

Page 5
Value Destruction
The US economy is great not because of its government, but thanks to its innovative companies, managers,
and risk-taking entrepreneurs — these are largely absent in the GCC economies, partly due to complacent
management, low investment in technology and poor strategies across the private sector.
The pandemic has blurred lines but the two in the chart below are unambiguous in showing a deteriorating
trend in Return on Equity (RoE) and Return on Assets (RoA) among listed Saudi companies.
RoEs and RoAs have more than halved
over the past decade and are lower
than their global peers.
A fund manager that invested in an
international portfolio delivering these
returns would have been sacked, and
yet executives continue to preside over
these outcomes with tired excuses.
Managers might spin a good story but
these undisputed numbers speak louder.
It’s worth highlighting that the deterioration in returns pre-date the pandemic by a decade, and while a
small rebound should be expected this year, it is unlikely to signal a sustained turnaround.
Despite conclusive evidence of eroding profit margins, most managers are in denial about the solutions.
It’s no wonder that 15 years after prices peaked the TASI is still down 50% despite trading at 38x earnings.
The development of net profit margins for listed Saudi companies can be divided into three phases:
1. Bubble: companies invested their cash
in stocks and real estate to inflate profits.
2. Old Normal: margins were padded by
subsidies and protective regulations.
3. New Normal: the removal of subsidies,
higher taxes, increased operating costs,
deregulation and disruptive technology.
Margins have now converged on global
levels and are set to remain in this range
permanently. There’s no going back. Ever.
With margins halved, sales need to double in order for aggregate profits to return to their prior peaks —
something that could take many years, even under favourable macro-economic conditions.
As highlighted in virtually every single edition of this publication, waiting and tinkering isn't the answer.
Wide-scale industrial consolidation and creative destruction is necessary. And it’s just not getting done!
9.2
13.8
5.9
1.4
0
5
10
15
20
25
2007 2009 2011 2013 2015 2017 2019 2021
Listed Saudi Stocks
Return on Equity Return on Assets
%
Source: Bloomberg, Nomura Asset Management
Pre-Financial
Crisis
Long term decline preceeding pandemic
FY 2019 Return On Equity Return On Assets
S&P 500 15.8 2.7
MSCI Asia (ex-Japan) 10.1 1.9
Bloomberg Europe 500 9.7 0.9
8
12
16
20
24
28
32
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Net Profit Margins (TASI)
Source: Bloomberg, Nomura Asset Management
%
New Normal
Bubble
Old Normal
FY 2019 Profit Margins
S&P 500 10.3
MSCI Asia (ex-Japan) 8.6
Bloomberg Europe 500 6.4

Page 6
Death by Stealth
The reaction of the private sector to the deterioration in financial metrics and an increasingly competitive
environment should be to reengineer operations and accelerate consolidation, as seen in the US during the
1970s, the UK in the 1980s and Japan in the early 2000s.
Unfortunately, there appears to be little appetite for wholesale changes with GCC owners continuing to
fund underperforming operations from more profitable companies, cash reserves or investment income,
while hoping for a turn in the economic cycle to bail them out again.
Such hopes are misplaced because of the deep structural elements that makes the current cycle completely
different to others. Yes, it is different this time, just as it was in the US, UK and Japan decades ago.
Because these adjustments have taken place before, albeit in different contexts and with some variations,
there is a great deal of certainty about how it will unfold and how to apply the survival playbook.
For those that choose not to read from the well documented past, returns will slowly deteriorate until
owners are forced to inject more capital or shut up shop. Companies will suffer death by a thousand cuts.
Shareholders that profited from the social contract but barely reinvested in expansion and innovation,
maximized dividend payouts and fostered low value-added ventures are particularly vulnerable.
Unfocused conglomerates are also exposed even if they can temporarily shuffle the chairs on the deck of
their sinking ships until wasteful cross-company support eventually weighs them all down.
These issues are common across the region, although the scale of the problem is only being uncovered in
places that have started to withdraw the social contract — Kuwait is still lavishing riches it can not sustain.
Interestingly some of the most successful privately founded Saudi companies (e.g. Xtra, Jarir) did not
particularly benefit from the social contract and are well placed to withstand its demise.
Other successful companies are majority state-owned, such as Aramco, SABIC, and STC that have led
investment, innovation and delivered stellar returns to all stakeholders.
The Saudi and UAE governments have been particularly proactive in their post-oil planning, for example by
encouraging bank mergers to create national champions and globally competitive institutions.
The PIF recently put its food related assets under SALIC to manage potential synergies and consolidation,
while hundreds of hopeless privately-owned sub-optimal food-related firms are starving (pun intended).
And though the privatization program has been disappointing (Aramco excepted) there are signs of an
accelerated process with prized assets, such as the Tadawul Group, primed for IPOs.
The task of rebuilding the economy is enormous but can be done one step at a time, and one company by
company, if each individual and every institution takes responsibility for their own destiny.
The GCC economy can prosper if the private sector is healthy, strong and can wean itself off the outdated
social contract in favour of a New Deal that incentivizes innovation and investment, instead of dependency.
This requires difficult decisions in the private sector and governments that will support the transition.

Page 7
Climate Economics
Over the past few years this publication has dedicated an extraordinary number of words to renewable
energy and the electrification of the auto sector because these have enormous implications for the region.
Countdown to Midnight (November 14th, 2016) boldly flagged
The End of Oil and warned about the impact of electric
vehicles (EV) on petrol demand.
Those warnings were wrong only because the scenario now
unfolding is even faster than expected!
The inflection point for EV sales (the bend in the ‘S’ curve)
that had been expected around 2030 may now happen
several years earlier.
Advances in battery technology, more charging stations,
lower mileage costs, and the politicization of the debate
around climate change has accelerated adoption forecasts.
President Biden’s infrastructure plan allocates $174 billion
for EVs, replaces subsidies for fossil-fuel companies with
new incentives for clean energy and threatens a gasoline tax.
The International Energy Agency recently posited that oil demand would recover in 2023 but that gasoline
demand may have peaked due to electrification and changes to commuting habits in the post-covid era.
The probability that consumers in developed economies will be buying petrol-engined cars in ten years is
practically zero — oil will be in demand across a range of other uses but not in the same quantities.
Also, the increasing importance of ESG investing among leading financial institutions has turned fossil-fuels
into an eleven-letter dirty word and led to a de-rating for related assets.
The financing of oil projects is becoming more difficult, just as it did for tobacco companies in the 1980s,
and this may constrain supply among the higher cost producers outside OPEC and allow low cost GCC
exporters to increase their market share. Lower supply could support prices over the longer term.
There are currently over 40 oil exploration and production companies listed on the global exchanges.
Many are majority owned by governments but there are already reports about potential mergers, including
a gigantic combination between Exxon and Chevron that was apparently discussed last year.
Deals of this magnitude may be speculative at this point but they are absolutely certain over the mid-term
as the industry comes to grips with its new (low) growth trajectories.
Of course there are also enormous implications for the global auto industry which employs tens of millions
in engine design and manufacturing, at parts suppliers, dealerships, service garages and petrol stations.
Like every technology that preceded them, electric vehicles will disrupt beyond their initial intention — it’s
worth remembering the selling point for the first iPhone was that it could make calls and play music!

Page 8
The Bottom Line
The GCC is in a fateful economic battle that has troubling cyclical, structural and systemic components —
it’s driven by risks around oil but also a disruptive post-pandemic digital world for which it is ill-prepared.
It is entirely conceivable that demand for oil from GCC exporters might continue to increase but this
should not be a base case for the hugely consequential decisions being taken today.
The social contract is redundant and a new Ta’awun deal is needed to reframe the relationship between
the public and private sectors in a way that reflects developments in the local and global economies.
Given low taxation and restrictive monetary policy instruments (by virtue of the Dollar peg), governments
have relatively limited tools to compel or even direct the private sector.
Moreover, governments (representing the national interest) should not be expected to underwrite broken
business models and inept management as they consider their own fiscal sustainability.
Instead of funding wasteful subsidies, and extending regulatory cover for declining companies, they should
offer incentives to support transition and reward positive, rather than negative, behaviour.
The Ta’awun program would do away with an outmoded social contract that benefited the privileged few,
and replace it with one that promotes meritocracy, reduces inequality and raises productivity and growth.
Inaction and the usual wait-and-see attitude increases the risk of sleepwalking towards an unfavourable
outcome.
“Change before you have to” and “Control your destiny or somebody else will“— Jack Welsh.
Ramadan Kareem
Tarek Fadlallah, CFA
Disclaimer: Nomura Asset Management U.K. Limited, Dubai Branch trading as Nomura Asset Management Middle East (“NAM Middle East”)
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