Mid-cap stocks offer best dividend yields in Gulf

Shutterstock

• GCC average stock dividend yields are now below the risk-free rate
• The 10 largest companies have an average yield of just 3.26%
• Mid-market listings offer yields as high as 19.7%

Dividend-seeking Gulf investors are likely to find little value among the region’s blue-chip stocks and should instead target mid-cap companies with steady cash flows and low debt, experts suggest.

When interest rates hovered near zero and average dividend yields on GCC stocks were around 4 percent, the difference with the risk-free rate – the return a depositor earns in a savings account at a major bank – was attractive.

Now, though, benchmark interest rates are over 5 percent and average Gulf dividend yields are less than 3 percent, despite a decline in equity valuations following a stock market sell-off since mid-2022.

• Aramco dividends outstrip rival blue-chips
• Saudi aims for 24 IPOs on Tadawul by end of 2023
• Tadawul and DFM are overvalued, data shows

The spread between the risk-free rate and dividend yields has turned negative for the first time, said Shakeel Sarwar, head of asset management at Bahrain investment bank Sico.

Akber Khan, senior director of asset management at Al Rayan Investment in Doha, says bank deposit returns are the primary competitor for all asset classes.

“What’s the opportunity cost of not investing?” he asks. “Currently, the cost is very low because so called risk-free returns from deposits are elevated across the Gulf.

“The return premium an investor seeks above the deposit rate to justify taking risk makes the calculus that much harder.”

Despite a Covid-led profit slump in 2020, companies kept dividends more or less unchanged in monetary terms for that year. Yet, as profits recovered in a post-pandemic economic rebound, firms did not increase dividends.

Data from Refinitiv shows that led dividend pay-outs as a proportion of profits to fall to 53.4 percent for 2022, its lowest level over the past 10 years.

Among the 10 largest listed companies in the Gulf that have paid regular dividends over the past five years, the average dividend yield was just 3.26 percent for 2022, according to AGBI calculations based on Refinitiv data.

Only Saudi Basic Industries Corp (Sabic) and Saudi Telecom Co offer a yield above 4 percent. Other large-caps, such as Saudi Aramco, UAE telecom operator Etisalat, and Saudi National Bank and its domestic rival Al Rajhi Bank, provide dividend yields of 1.6 to 4 percent.

Focus on the mid-market

Banks and commodity producers are the largest constituents of Gulf equity indices. Both endured a difficult 2022 as commodity prices fell and governments used hydrocarbon revenue windfalls to repay significant chunks of their domestic bank borrowings.

Likewise, many of the Gulf companies that went public last year deployed some of their IPO proceeds to reduce their bank debt. Many banks also struggled with margins as their cost of funding soared.

“Cyclicality shouldn’t be forgotten when analysing dividend yields,” says Khan. “Bank balance sheet growth has been insipid and margins haven’t impressed despite rate increases. Many large regional banks are telling their investors to expect a better second half of 2023. For now, markets are sceptical.”

Dividend-seeking investors should instead target mid-cap companies. Abu Dhabi’s Fertiglobe dividend yield of 19.7 on last year’s earnings is the biggest in the Gulf, Refinitiv data shows, because of record high fertiliser prices last year.

“It can still pay 7 to 8 percent in the medium term,” says Sarwar.

Most other companies offering double-digit yields are also likely to provide lower returns in future. Soaring metals prices lifted Aluminium Bahrain’s (Alba) dividend yield to 10.6 percent, while the UAE’s Dana Gas similarly benefitted from record gas prices following Russia’s invasion of Ukraine that boosted its dividend yield to 11.0 percent.

However, says Sarwar, “These aren’t sustainable, because they were due to a commodities bull cycle.”

There are 30 to 40 companies offering sustainable dividend yields of 5-10 percent, he adds: “Many of these are in the utilities or telecoms sector, where cash flow yields are higher. Investors can earn a decent spread over deposit rates and also benefit from moderate share price increases.”

Aside from utilities and telecoms, there are companies in other industries that also offer strong dividend yields. Industries Qatar and UAE’s RAK Ceramics, for example, have excellent cashflow and little debt, so can pay dividend yields of more than 7 percent.

Khan says the highest-yielding stocks are sector-agnostic. These can include, for example, real estate companies, industrial manufacturers and cement makers.

“It’s not about sectors or countries, it's about individual companies, and mostly those that have lower leverage,” says Khan. “The common factors are more often related to balance sheet strength, quality of management, visibility provided by business models and competitive positioning.”

Rising interest rates and declining dividend yields may pressure companies to increase pay-outs, especially among the bluechips. In May, Saudi Aramco announced plans to pay a performance-linked dividend in addition to its base pay-out.

“We should expect something similar in other large caps, especially those that are state-owned,” adds Sarwar. “Stocks won’t be attractive to investors unless interest rates start falling and dividend yields rise – there has to be some convergence.”