GCC corporate profits shrink on falling oil prices

Muscat: Corporate profits and net margins, at an aggregate level, have shown a downtrend for most sectors in Gulf Cooperation Council (GCC) as they continue to face headwinds from plummeting oil prices, according to Marmore Mena Intelligence, a research subsidiary of Kuwait Financial Centre ‘Markaz’.
This has resulted in slower economic growth in the region and reduced government spending. However, the aggregate profit margin conceals a broad divergence of trends among various sectors, said the report highlighting industries that enjoy high net profit margins across GCC.
Interestingly, the net profit margins of large cap stocks (5-year average of 17.5 per cent) in GCC were much higher than those of mid cap (5-yearr average, 9.9 per cent) and small cap stocks (5-year average, 5.8 per cent. Outperformance is possible as most large caps such as Sabic, Qatar Industries and Emaar Properties often enjoy extra government patronage in terms of contracts, access to raw materials and funding, it said.
The research note also said the net margins varied widely among the sectors depending on the size of their operations. For instance, large-cap telecom companies like Emirates Telecommunications, Saudi Telecom and Ooredoo with their first mover advantage and government support, have enjoyed healthy double-digit margins while mid-cap telecom companies in the region were weighted down by poor performance from two operators — Vodafone Qatar and Mobile Telecommunications (Saudi Arabia). These two companies are relatively new entrants to the market and are yet to break-even.
Phenomenon of negative margins was witnessed largely in small-cap sector especially in companies operating in telecom, technology and energy sectors. This could be because they are still establishing themselves to gain a foothold, it added.
Profit margins in sectors such as basic materials, industrials, energy, utilities and telecommunication services were affected by various factors. Subdued activity in infrastructure space, softening real estate activity as evidenced by stagnating sales and prolonged working capital cycle has eroded margins for contractors, construction material providers such as cement and steel companies and infrastructure firms by 200bps to 800bps over the past five years.
For companies operating in energy and industrial sectors, lower realisations for petrochemical products and stronger currency has affected margins; intense competition leading to declining average revenue per user (ARPU), saturated market and foreign exchange losses have restrained profit margins for telecommunication service providers.
On the other hand, there are sectors that have bucked the trend and successfully expanded their margins as well. Firms in technology, financials – particularly Non-Banking Financial Corporations (NBFCs), healthcare and consumer non-cyclical sectors have all done well in the past five years. Margins for firms providing financial services such as loans, working capital, insurance, wealth management products and leasing solutions have expanded by 980bps in the past five years. Lower cost of capital, ample liquidity and regulations that call for mandatory purchase of insurance have aided in their stellar growth.
Food processing firms, retailers, wholesale distributors and traders for whom the consumer demand is resilient to vagaries of business cycle have also done well. Favourable demographics, rising per capita incomes and a lifestyle which is consumption-driven have benefitted the consumer non-cyclical sector whose margins have increased by 480bps since 2011.
Higher margins, per se, do not translate into wealth creation. For instance, basic materials and industrials sector which have higher margins than technology and consumer non-cyclicals have underperformed in terms of wealth creation for shareholders. In fact, the largest shareholder wealth creator in the past five years, consumer cyclicals sector has one of the lowest margins.
Thus, profitability is just one part of the equation. Profitability along with growth, which can be sustained for long-term would add significant value to the shareholders. Identification of opportunities for growth thus assumes significant importance for the management team. While profitable operations ensure survival of the firm, evaluating growth opportunities and successfully investing in them would ensure value addition and long-term success.