Earnings outlook intact, while cheap valuation has become even cheaper; Stay OW 

The 8% drop in the EGX last week was overdone as local investors continue to ignore the strong EPS growth outlook, and attractive valuation. Egypt now offers the highest upside in EM and MENA, and historically valuations from here in the subsequent 12 months have returned +59% on average. While the persistent high interest rate environment, ongoing EM uncertainties, and recent news flow are not supportive for local sentiment/flows, the indiscriminate sell-off is not justified by fundamentals, in our view. We remain confident that fundamentals will prevail in the medium/long term, however we see significant risk to our end-year EGX30 target of 19,112 amidst a lack of strong ST catalysts for the market and recent EM multiples de-rating. We have been OW on Egypt since 3 Nov 2016 (+28.6% in USD terms, outperforming EM, FM, and MENA-x-KSA), and our Egypt portfolio continues to outperform despite a tough 2018. We cannot justify a change in our view on Egyptian equities given current valuations, EPS growth, and the medium-term outlook for local interest rates. Investors who have excess cash should take advantage and average their cost down.
 
Macro stability sustains; maintain forecasts for EGP and rates …

The strong foreign reserve position and stable inflation outlook provide us with relative comfort on Egypt’s macro outlook as it deals with heightened global market volatility. The economy has already seen nearly USD8bn portfolio outflows without putting any notable pressure on foreign reserves or the currency. This should come as no surprise given the way the Central Bank of Egypt (CBE) initially managed the flows when they first came in – the flows were circumvented from the wider system thanks to the repatriation mechanism, which parked most of the flows in an ‘unofficial’ reserve account. This meant that the EGP made minimal gains on the way up and will make minimal losses as the flow has reversed. We therefore maintain our forecast of a trading ceiling for the USD/EGP of EGP18.10/15 over the next six months. A stable EGP outlook is also supported by a weak domestic demand backdrop, leading to relatively tame non-capital demand for hard currency. Immediately, we see the spillover into Egypt largely resulting in higher domestic interest rates for longer, feeding into our forecast of no policy rate cuts until at least next summer. Treasury yields have already jumped 250-300bps since April, reflecting the interruption of the easing cycle and tightening liquidity conditions. 
 
… but risks remain elevated

We see two key risks to Egypt’s macro outlook for the next 12 months, further: i) acceleration in global oil prices; and ii) EM/FM volatility leading to faster capital outflows. Oil prices stabilising above USD80/bbl would render the fuel price hike planned next summer (the target is to liberalise fuel prices) much more costly from an inflation perspective thereby risking policy rates remaining higher for longer. Meanwhile, heightened global volatility could cause more portfolio outflows and higher borrowing costs. While we see limited risks for reserves drawdown, the pace of portfolio outflows if maintained would cause some concerns amongst local players and lead to higher volatility in the USD/EGP rate. Such heightened volatility might also make it difficult for Egypt, as with other emerging economies, to revisit global capital markets at reasonable interest rates for its USD4-5bn planned Eurobond issuances. This would pressure local Treasury yields even further, leading to a widening of the fiscal deficit (although the primary balance would continue to improve). Higher rates for longer, risk i)  pushing the capex recovery by six to twelve months; and ii) leaving the gov’t with elevated borrowing costs, which could mean a wider overall fiscal deficit. 

Mohamed Abu Basha

Mohamad Al Hajj