EQNR - ENOR: Norwegian Stocks Are Unbelievably Undervalued

2023-07-21 14:08:42 ET

Summary

• Norwegian stocks are extremely undervalued, offering an 8% dividend yield and trading at a PE ratio of around 6x, making them a great investment opportunity.
• The Norwegian krone is also undervalued by 35% in purchasing power parity terms, despite the country's solid economic fundamentals.
• If both the MSCI Norway and the krone revert back to long-term average valuations, the Global X MSCI Norway ETF would triple in value.

Norwegian stocks represent one of the best opportunities I have seen in 20 years. The MSCI Norway trades at a PE ratio of around 6x and offers an 8% dividend yield, while the Norwegian krone is 35% undervalued in purchasing power parity terms. If the stock market and currency valuations were to mean revert back to long-term averages, the Global X MSCI Norway ETF ( ENOR ) would rise threefold.

The ENOR ETF

The iShares MSCI Norway ETF seeks to track the investment results of a broad-based index composed of Norwegian equities, which have a current market cap of $225bn. The ETF is heavily weighted towards energy stocks, which command a 31% weighting, with state oil company Equinor ( EQNR ) alone representing 18% of the index. Financials and consumer staples are the second-largest sectors with 20% and 13% respectively. The top 10 companies on the index represent almost 60% of the total market. While the reported dividend yield on the ETF is 4.7%, this should be expected to rise as the underlying MSCI Norway has a yield of almost 8%. The fund charges an expense fee of 0.53%.

PE Ratio Trading At A 69% Discount To The MSCI World

Regardless of the valuation metric used, Norwegian stocks are trading at severely discounted levels, both compared with their own history and developed market benchmarks. The trailing PE ratio of just 6.4x is in the bottom 1% of all valuations in data going back to 1996, and is a staggering 69% discount to the MSCI World. Based on the historical correlation between relative valuations and subsequent performance, this discount implies 10% annual excess total returns for MSCI Norway.

Part of this valuation discount can be attributed to unsustainably high profit margins, which currently sit at 14% compared with around 10% for the MSCI World. Rising oil prices have helped drive record margins across the energy sector, and their decline over the past year is yet to be reflected in reported earnings. However, even if we completely ignore profit margins the MSCI Norway still trades at a 52% discount to the MSCI World on a price to sales basis, after trading at a premium to it just 5 years ago. Such a discount has been consistent with around 6% annual outperformance over the following decade.

The market's undervaluation is also reflected in MSCI Norway's huge dividend yield of almost 8% %, which is almost 4x higher and 6pp higher than the MSCI World. Investors do not require any narrowing of the valuation gap for the ENOR to significantly outperform the global benchmark. When you consider that MSCI Norway dividends per share have a long-term track record of stronger growth relative to the MSCI World, it is hard to imagine the dividend outlook shifting so significantly as to result in continued ENOR underperformance.

Currency Outlook Equally Compelling

The undervaluation of the Norwegian krone is equally impressive. Despite the Norges Bank's aggressive interest rate hikes and a whopping 28% current account surplus, the krone has weakened significantly this year, which seems completely at odds with the country's solid fundamentals. The World Bank's Purchasing Power Parity index puts the currency 35% below fair value, as the near halving of the currency's value against the dollar over the past decade has come despite similar levels of inflation in Norway and the US.

This currency devaluation has been a major driver of the ENOR's weakness over this period as seen in the chart below which compared the performance of the ENOR which is based in USD versus the MSCI Norway in local currency terms. The krone has declined 40% over the past decade, resulting in a 19% decline in the ENOR even as the market has risen 34% in local currency terms. The strong rally in the krone on the back of the recent drop in US CPI may be the trigger that allows the currency to move back towards fair value and contribute positively to ENOR returns.

Already Priced For A Sharp Drop In Crude Oil

The main risk to the ENOR comes from the volatile price of oil. As one would expect, the ETF is extremely closely correlated with the price of Brent crude oil and a sharp drop in prices would almost certainly cause weakness in the ETF. However, the ENOR is already trading at a significant discount to the MSCI World Energy sector which itself is undervalued, suggesting that a significant fall in oil prices is already very much priced into ENOR.

Summary

If both the MSCI Norway and the krone were to move back to the long-term average valuations, the ENOR would more than triple in value. If the valuation discount remains in place, investors can expect to earn around 8% annually in dividend income, almost 6pp higher than the MSCI World. Considering the long-term track record of strong dividend growth and the country's rock solid macroeconomic fundamentals, the ENOR is a gift of an opportunity at current levels.

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