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CIO team, 21.06.2018
MSCI Inc. has added both Saudi Arabia and Argentina to its Emerging Market equity index, an upgrade from their previous status. FTSE had already included the KSA in its Secondary Emerging Market Index in its March review. The KSA has a market cap of 2.2% of EM equities and the CEO of the Tadawul bourse estimates inclusion would lead to inflows into the KSA equity markets of c. $40bn. YTD inflows in Saudi have been in the range of $3Bn. MSCI is the market leader with an estimated $1.9 trillion in assets benchmarked to its group of EM indices. The implementation of the inclusion will start in May 2019 and the KSA is due to represent around 2.6% of the index with 32 securities.
The potential for an MSCI inclusion has made the Saudi Tadawul Index attractive for foreign investors, turning it into the world’s second-best performer this year. The US listed iShares MSCI Saudi Arabia ETF jumped 2.4 percent post-market trading yesterday.
Exhibit: One Year Performance of the Saudi Tadawul Index and the Saudi Bank Index
Source: Bloomberg 12th June 2018; Rebased to 100
The KSA has historically traded at a premium to emerging markets. Saudi markets have had a strong performance this year with the Saudi Index up 13%, led by the Saudi Bank Index up 25.7%. The MSCI EM Index is down 5.6% year to date. This has led to a wide divergence in valuations with the KSA trading at a 12 month forward Price to earnings of 15.2X compared to the MSCI EM at 12.0X.
Exhibit: Price to Earnings Comparison: Emerging Markets compared to the KSA
Source: Bloomberg, Monthly PE June 20th 2018
Petrochemical global leader, Saudi Basic Industries Corp. and the leading Islamic Bank Al Rajhi are expected to see the biggest inflows following the MSCI upgrade as they comprise almost a quarter of the Saudi Index.
The upgrade sets the stage for the Aramco IPO, another event that could boost liquidity. The sale, originally planned for the second half of this year, is now likely in 2019, the KSAs oil minister said last month. Saudi Arabia hopes to sell 5 percent of the world’s largest oil exporter, valuing the company at more than $2tn. When listed, the Saudi Aramco would add c. 2.4% to KSA’s weight in the EM Index. Other IPOs in the pipeline too would add to the weight – Saudi Airlines, Saudi Exchange, and Saudi Airports.
Table: Saudi Market Statistics
Source: Bloomberg 20th June 2018
For Saudi Arabia the upgrade will help improve liquidity after regulators implemented a series of changes aimed at adapting the bourse to international standards. The KSA is under-invested by foreign active managers and the inclusion will help change this. Foreign ownership of Saudi stocks is below 5% much lower than the UAE which has been a member of the MSCI EM Index since 2014.
Exhibit: Ownership Breakdown of the KSA Equity Market
Source: Bloomberg, Tadawul as of June 7th 2018
The KSA’s population of 30 million, two thirds below the age of 30, provide the demographics for increasing consumption alongside a strong workforce to grow the economy. Social reforms to empower Saudi nationals, particularly youth and women will pay off with increased workforce participation.
Following three years of economic slowdown, fiscal policy is now more expansionary. Capital spending is set to rise. Budget capex is projected to increase by 14%.This should be complemented by additional investment spending from the Public Investment Fund and the National Development Fund.
“Saudi Arabia’s Vision 2030” was adopted as an approach and a roadmap for economic and developmental action in the Kingdom of Saudi Arabia. The goal is to spur multiple different new industries within the country and diversify the economy and dependence of Saudi Arabia away from oil exports. Business and industrial zones are in progress, such as the NEOM project, which will focus on industries including energy and water, biotechnology, food, advanced manufacturing and entertainment.
We remain overweight the banking sector in the KSA on a higher rates outlook and the petrochemical sector on stable and improving oil prices. These sectors also have larger trading volumes and potential inclusion of a number of stocks. We highlight Al Rajhi Bank, NCB, Samba, Bank Saudi Fransi, SABIC, Yansab and APPC as potential entrants to the EM indices.
Equity market valuations are not cheap compared to EMs, but nor are they expensive on a historical basis. Current troubles in Latin America as well as US/China trade concerns also explain part of the difference with overall EM equities.
Saudi banks should benefit from widening NIMs as US rates rise. Credit growth should accelerate as the economy picks up pace with higher oil prices leading to higher government revenues. Dividend yields are attractive. The construction sector should benefit from government spend on infrastructure. Retailers will benefit from increased salaries and bonus payments to the government and military. Expanded private medical insurance should drive long-term gains for private hospitals.
Our preferred allocation to the KSA market:
Banking: Liquidity issues are improving. Loan to deposit ratios have now stabilized. Dividend payout is being maintained. Higher rates are positive for Net Interest Margins. Saudi banks have c.60% low cost CASA deposits hence higher local rates are positive for NIMs
Petrochemicals: The rally could continue as with Brent above $70, product prices will move in line. Companies like SABIC which is a global chemical leader is growing both organically and inorganically and diversifying out of the KSA.
Healthcare: Greater use of private sector healthcare is strongly supported by the government
Consumer: The rally in oil prices is finally flowing through to spending
Telecom: Dividend payout has been maintained, though earnings growth is muted. Increasing use of data and young demographics will drive cash flows
Contractors: Facing receivable issues with margins contracting
Exhibit: Potential entrants to the MSCI EM Index
Source: Bloomberg, 21st June 2018
Please refer to our list of recommended stock ideas for further details (available with your investment advisors.)
Wealth Management – CIO Office. Contact: +971 (0)4 609 3564
Anita Gupta – Head of Equity Strategy
Nawaf Al Naqbi – Equity Analyst
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