Q. What role does sukuk play within Dar Al-Arkan’s overall funding strategy?
A. Sukuk in general plays a very important role in our funding strategy. Across our debt portfolio, and including this prefunding repayment for 2018, sukuk accounts for about 72% of all funding, with 28% allocated to Murabahas. Our sukuk issuances have mostly carried tenors of about five years, as they sit nicely within our development cycle.
Looking at sukuk performance last year, it was a very volatile market and prices on these instruments largely dropped due to investors’ margin calls – it was trading around 75 cents on the dollar. This was mostly due to uncertainty over the oil price. These high-yield Middle East bonds are often used by hedge funds, or those who buy with leverage, to sell off once prices drop. This was the backdrop for the company’s latest issuance, but Dar Al-Arkan’s fundamentals didn’t really change.
Q. What kind of challenges did Dar Al-Arkan encounter en route to tapping the debt markets, and how were they overcome?
A. The Saudi real estate market, with ongoing consolidation and tough land taxes on the horizon, meant that our revenues were down and credit multipliers worsened quite a bit over the past two years.
Yet, despite this backdrop, we saw that liquidity was there for sukuk in Q12017, as there weren’t many other corporates tapping this market. We worked with CRAs and were upgraded by Moody’s the week of the issuance. We carried out extensive roadshows in London, Middle East, Singapore, Hong Kong and other territories, meeting investors across the globe, and ended up with a successful USD500mn benchmark issuance in May.
We were very happy with it, and the pricing shows the market was satisfied, too. All three sukuk at the time were trading steadily, so it is clear we made the right call on the timing of the transaction.
Q. What were the major concerns expressed by investors during your roadshows?
A. There were two layers to this issuance. When KSA did their jumbo deal in late 2016, the roadshow saw a huge attendance. It created an interesting “before” and “after” sense in the market; following that deal the message from the Sovereign about plans to tackle the deficit and achieve their 2030 goals became quite clear for institutional investors. Afterwards, the discussion was no longer about sovereign risk, but solely about sector and company risk.
Another point was that early in 2017 the bond market began to open up and the Fed’s plans were crystalizing, all of which helped to alleviate some of the earlier uncertainty. As supply was low at the time, it opened a good window for us to tap the market.
Q. What is the outlook for the real estate sector in GCC for the next few months? It traditionally hasn’t attracted a lot of foreign interest, compared to some other sectors. Do you expect that to change in the next year?
A. Real estate in Saudi Arabia is in a period of change, driven by a number of factors. Banking is one: KSA has been setting up the mortgage industry and revamping regulations, which came about in 2016. On the back of that, you start to see banks extend loans in compliance with the new laws, and also set up a platform for doing off-plan selling, based on a new regulatory programme. These were some of the positive factors seen on the funding side.
Looking at the demand and supply side, there were some new initiatives: for example, the Ministry of Housing initiated a major programme to encourage private sector players to bid on affordable housing projects; that process is ongoing. The land tax was another factor: it was unclear up until Q12017, when we finally got some feedback and details about the new taxation system. Thankfully, we were able to relay to investors that it won’t have a negative impact, and that the outlook for the sector in longer term is actually quite bright.
Real estate in Saudi Arabia is diversifying. Our core market are the Tier 1 cities in the Kingdom, which include Riyadh, Jeddah, Medina, Mecca and Dammam – that’s where most of our assets are based. These core markets in Q12017, for the first time in a while, saw a swing in pricing – for villas and apartments, prices went up around 5% year on year. One of the key drivers in Mecca was for the government to remove the 20% limit on the Hajj visas, which had a positive impact on this market. As for Riyadh and Jeddah, property prices went dropped 1% down sequentially, and about 5% year on year, so the overall trajectory is still downward. I think the consensus is we will see a bottoming out of the market in 2017, with a recovery beginning in 2018. Once confidence increases, on the back of the uptick in GDP growth predicted for 2018, we expect to see the market bounce back.
=Q. What does Dar Al-Arkan’s business plan look like for the forthcoming 24 months? What is your growth strategy, and how is the company differentiating from its peers?
A. In land development – a core revenue generator for us – we have a very a strong foothold, about SAR14bn in historical cost saving in our balance sheet, mostly located in Jeddah, Mecca and Riyadh. We continue to invest into our land, putting money into infrastructure development; we plan to continue selling, and maintaining quite high margins.
Second, we have a property management and leasing portfolio of about SAR3.4bn which contains residential and commercial properties for lease. Here our strategy is to continue growing our occupancy levels by looking for corporate and individual customers. We are refurbishing some existing properties and are also repositioning the lease portfolio by taking part of the assets for sale to improve occupancy – essentially optimising our general portfolio.
Third, in residential and commercial development: we have about SAR3bn portfolio of masterplan communities in Tier 1 cities in KSA, and we continue to work with authorities on development approval. In Jeddah and Riyadh, we will secure approvals and plan to start projects in 2018, which will generate off-plan selling revenue for us going forward.
We are launching properties for sale from existing portfolios under this business line. So, we are building sales and marketing capacity in the company as we hope to support the rebranding and launching of this initiative.
We are also pushing out into international markets. We’ve been monitoring Dubai, for example and looking to develop residential luxury apartments in locations like Dubai, where 30-35% off all residential units are sold to Saudi nationals. It begs a question: why is there no Saudi developer to serve that demand?
Finally, in housing, our objective is to participate in the tenders offered by the Saudi government on affordable housing projects. We were involved in a few of these, and plan to take part in more of them. This is a fast-growing, competitive sector, but we are not there for charity: we expect to make decent returns, otherwise we wouldn’t be involved. Profitability in this business hangs on contracting, so earlier this year we decided to acquire a contracting agency. The logic is to reduce costs and delivery times on overall developments, while being able to control the quality and the supply chain.
Q. How will Dar Al-Arkan’s approach to the capital markets and fixed income evolve going forward? What are the most influential factors in play here?
A. Looking at property management and leasing, where you have incoming producing assets and properties on long-tenor leases, those are typically funded via local loans with longer tenors – you can see that in our maturity profile. Funding is cheaper when you have collateralized structures with local banks. In terms of residential/commercial development, for instance, developing off-plan selling residential units, that is mostly funded by customer down payments and milestone payments, so it is mostly cash-flow neutral.
As for housing projects, the cashflows tend to turn negative at the beginning of the cycle, so sometimes it requires project financing from local banks. And when we look at masterplan long-term developments, where capital is tied to a long cycle, those projects are great to fund through sukuk with tenors of five or more years.
Looking at our debt portfolio, we have 3 sukuk outstanding, with the 2022 sukuk used to prefund the 2018 (around USD450mn). Next summer we will need to finalise how to manage our 2019 sukuk, so we might look to tap the debt markets again – either to prefund or a tender offer, or some other manoeuvre. Companies need to be flexible in the types of instruments and products they use to manage their finances – and we are one of the few Saudi companies to have a credit rating and access to the international markets, which makes our life a lot easier.
Q. What are the key challenges you think CFOs and treasurers in the region will face over the coming 12 months? How are you aligning your business to overcome these challenges?
A. Looking at the big picture, for Saudi Arabia there are a few traditional concerns. First is the oil market: there is still oversupply, the inventories will drop in the summer but start to pile up towards the end of the year, so they will push the price downward. If OPEC fails to act, we will see another drop. I don’t believe the drop will be prolonged, but it may still lead to the same issues we’ve seen in MENA before – namely, a slowdown in investment – and will need several months to recover. That is a clear risk.
Another aspect to consider in the KSA is the continued fiscal consolidation, namely cutting of energy and water subsidies, which cuts into disposable incomes. On top of that, we have the incoming VAT tax, which could add 5% on nearly everything, including consumer stables.
That said, we anticipate quite a tough year ahead with some upsides. Timing will be very important in this environment – corporates will look to issue sooner rather than later.
