KSA - KSA: Assessing Potential Value For 2024 And Beyond

2023-12-20 22:21:54 ET

Summary

• The iShares MSCI Saudi Arabia ETF offers global investors access to Saudi Arabia's equity market and its evolving economy.
• The drivers fueling the growth of Saudi Arabia's economy into 2024 and beyond are varied, demonstrating a comprehensive strategy aimed at strengthening and diversifying the economy.
• The valuation metrics of the ETF compared to those of a hypothetical U.S. ETF highlights potential undervaluation, making it an appealing investment option considering the market dynamics and growth opportunities.

The iShares MSCI Saudi Arabia ETF ( KSA ) presents a unique investment vehicle, offering global investors a gateway into Saudi Arabia's evolving equity landscape. This ETF includes a broad spectrum of Saudi Arabian equities, providing diversified exposure to a market traditionally perceived as less accessible. It mirrors the performance of the MSCI Saudi Arabia IMI 25/50 Index, which represents the lion's share of the Saudi equity market??.

Saudi Arabia's significance in the global market is profound, largely underpinned by its pivotal role in the energy sector as a leading oil producer. Yet, there's more to the story than just oil. As the largest economy in the Middle East , with a GDP exceeding $1.07 trillion , Saudi Arabia stands as a beacon of economic potential in the region??. The nation is actively pivoting from its historical reliance on hydrocarbons, undertaking ambitious diversification efforts under the Vision 2030 initiative. This plan aims to reshape the economy, fostering growth in non-oil sectors such as tourism, technology, and renewable energy??.

The Investment Opportunity

The investment appeal of the KSA ETF extends beyond the conventional oil-centric perception of Saudi Arabia's market. It represents a strategic entry into the Kingdom's ambitious economic transformation. Under Vision 2030, Saudi Arabia is actively diversifying its economy, lessening its reliance on oil, and nurturing sectors like technology and finance. This diversification is pivotal in shaping the future of the Saudi market and, consequently, the KSA ETF.

Investors in the KSA ETF are positioned to capitalize on Saudi Arabia's vigorous economic expansion, robust capital market growth, extensive economic diversification initiatives, and sweeping legal reforms. The emphasis on burgeoning sectors, as outlined in Vision 2030, highlights the opportunity for diversified, sustainable investment returns, signaling a new era in the Kingdom's economic evolution.

Key Drivers of Saudi Arabia's Economic Evolution in 2024 and Beyond

The catalysts propelling Saudi Arabia's economy into 2024 and beyond are diverse, reflecting a broad-based strategy for economic fortification and diversification.

The Mega-Projects

Saudi Arabia's Vision 2030 encompasses a variety of ambitious projects, backed by a budget totaling several hundred billion dollars, all focused on diversifying and revitalizing the country's economy. Major projects under Vision 2030 include the " Journey Through Time " to develop Al Ula as a cultural destination; Qiddiya , Riyadh's entertainment capital with a Formula One racetrack and theme parks; Neom , a $500 billion high-tech city; the Red Sea Project , a sustainable luxury resort; Jabal Omar in Makkah for Hajj accommodation; Amaala , a luxury Red Sea tourism project; and Ad Diriyah , a luxury resort near Riyadh. Additionally, there are large-scale developments like Al Widyan, King Salman Park, Jeddah Tower, metro systems in Jeddah and Riyadh, and the Sharaan Nature Reserve, all contributing to Saudi Arabia's dynamic, sustainable economic transformation.

Visa Reforms

Newly implemented visa reforms are set to attract expatriates and enhance business incentives, fueling corporate and SME growth and thereby injecting dynamism into the economy.

Tax Incentives

The introduction of a 30-year tax exemption for foreign companies establishing regional headquarters in Saudi Arabia is a strategic move to lure multinational corporations. This policy is anticipated to bring fresh talent and innovation, stimulating economic activities.

Expo 2030

Hosting Expo 2030 in Riyadh is a strategic move to bolster the non-oil economy and boost international tourism. This, along with other high-profile international events, is expected to enhance Saudi Arabia's global standing and economic influence????.

Expansion in Hospitality and Tourism

The Kingdom's significant investments in hospitality and tourism, including the expansion of religious tourism and the development of new tourist destinations, have already yielded impressive growth, marked by record tourist numbers.

As such, the economic outlook for Saudi Arabia appears cautiously positive, indicating a move towards a more varied and sturdy economic framework. In fact, recent provisional data from the General Authority for Statistics (GASTAT) shows that Saudi Arabia's real Gross Domestic Product ((GDP)) experienced a 1.1% year-on-year increase in the second quarter of 2023. This growth is attributed to a 5.5% rise in non-oil sectors and a 2.7% growth in government service sectors. In contrast, oil-related activities saw a 4.2% decline over the same period.

KSA ETF Analysis

The iShares Saudi Arabia ETF seeks to mirror the performance of the MSCI Saudi Arabia IMI 25/50 Index. This ETF not only diversifies an investor’s portfolio geographically but also offers a chance to capitalize on the burgeoning potential of Saudi Arabia's evolving economy. As shown in the below chart, its performance closely correlates with the price variations of the Tadawul (TASI) index, making it an appropriate investment option for those looking to gain diversified exposure to the leading companies on the Saudi Stock Exchange (Tadawul).

As of December 2023, the iShares MSCI Saudi Arabia ETF includes over 120 companies, offering a broad representation of the Saudi market by covering both large-cap and substantial small-cap segments. It is diversified across various sectors, prominently featuring top companies in Financials, Energy, Communication, and Materials. This composition ensures comprehensive and balanced investment exposure to the Saudi Arabian market at an expense ratio of 0.74%.

The top holdings by market value and sector are:

• Al Rajhi Bank (Financials): 13.52% of the ETF's assets;

• The Saudi National Bank (Financials): 8.95%;

• Saudi Arabian Oil (Energy): 7.22%;

• Saudi Telecom (Communication): 5.97%;

• Saudi Basic Industries (Materials): 5.88%.

The top 10 holdings make up 56.77% of the total assets of the ETF. It has assets under management totaling approximately $767 million, and its liquidity is also noteworthy, evidenced by an average trading volume of around $22.58 million. Additionally, it pays a semi-annual dividend payment with a twelve trailing month yield of 2.12%.

Valuation and Outlook

To value the iShares MSCI Saudi Arabia ETF against a comparable U.S. investment, we will construct a benchmark using the sector weights of the KSA ETF. The method involves calculating a weighted average for each financial indicator in a way that mirrors the sector breakdown of the KSA ETF.

Here's how I approached the comparison:

1. Calculate weighted averages for the hypothetical benchmark : For each sector in the KSA ETF, I took the corresponding U.S. sector metric and multiplied it by the sector's weight. Summing these figures across all sectors will provide us with the weighted averages for our benchmark.

2. Compare the KSA ETF to the U.S. benchmark : Now we can assess how the KSA ETF's metrics stand in relation to the benchmark. This will help us understand if the KSA ETF is valued similarly to how a U.S. ETF with the same sector makeup would be.

The weighted averages for the hypothetical U.S. ETF, designed to mirror the sector breakdown of the KSA ETF, are calculated as follows:

Here are the financial metrics of the hypothetical U.S. ETF with the same sector breakdown as the KSA ETF:

• Weighted Average P/E : 17.08x
• Weighted Average P/B : 2.71x
• Weighted Average Beta : 0.85
• Weighted Average Standard Deviation : 19.28%
• Weighted Average TTM Yield : 1.72%

Now, let's compare these weighted averages to the KSA ETF's metrics:

• KSA ETF P/E : 16.88x
• KSA ETF P/B : 2.3x
• KSA ETF Beta : 0.49
• KSA ETF Standard Deviation : 17.97%
• KSA ETF TTM Yield : 2.23%

Comparative Analysis:

• Price-to-earnings (P/E) Ratio : The KSA ETF has a slightly lower P/E ratio (16.88x) compared to the U.S. benchmark (17.08x), indicating it may be slightly undervalued or more attractively priced based on earnings.
• Price-to-book (P/B) Ratio : With a P/B ratio of 2.3x, the KSA ETF is also lower than the U.S. benchmark's P/B ratio of 2.71x, which can suggest it is undervalued in terms of book value.
• Beta : The KSA ETF has a beta of 0.49, which is significantly lower than the benchmark's beta of 0.85. This indicates that the KSA ETF is less volatile than the benchmark.
• Standard Deviation : The standard deviation for KSA ETF (17.97%) is lower than that of the benchmark (19.28%), implying less risk and volatility.
• TTM Yield : The KSA ETF's yield (2.23%) is higher than the benchmark's yield (1.72%), which may make it more attractive to income-seeking investors.

Accordingly, considering the valuation metrics and assuming that the sectors in the U.S. market provide an appropriate benchmark, the KSA ETF seems to be somewhat undervalued relative to a hypothetical U.S. ETF that shares a similar sector composition. This is characterized by its lower volatility and superior yield. Furthermore, when incorporating the specific catalysts of the KSA economy, including its unique market dynamics and potential for growth, the KSA ETF presents itself as attractively priced. Given these factors, it is anticipated that for the year 2024, the KSA ETF will perform favorably when compared to a U.S. benchmark with an equivalent sector distribution.

Risks

Investing in the iShares MSCI Saudi Arabia ETF presents several risks that potential investors should be aware of:

Investing in Saudi Arabia: General Risks

1. Oil Dependency : Saudi Arabia's economy is heavily reliant on oil exports, which account for a significant portion of government funding. Fluctuations in oil prices can therefore greatly impact the country's economy, affecting public spending and employment rates. Falling oil prices could lead to reduced public spending and increased unemployment??.
2. Geopolitical Tensions : The Middle East presents a complicated and unstable geopolitical environment. Conflicts with neighboring nations often intensify swiftly, affecting the economic landscape. In a notable instance, the KSA ETF experienced significant net withdrawals in October , exceeding $200 million. This represented a 20% reduction from its holdings at the start of the month, coinciding with escalating tensions in the region.
3. Economic Diversification Efforts : While there are ongoing efforts to diversify the economy away from hydrocarbons, the success and impact of these initiatives are still developing. The transition from an oil-dependent economy to a more diversified one presents its own set of risks and uncertainties??.

Investing in the iShares MSCI Saudi Arabia ETF: Specific Risks

1. Sector Concentration and Cyclicality : The KSA ETF has a significant concentration in the financials and materials sectors, which are cyclical in nature. This makes the ETF's performance highly dependent on economic cycles, potentially leading to higher volatility during economic downturns????.

2. Influence of the Global Business Cycle : The current contraction phase of the global business cycle has a significant effect on the ETF. Moreover, fluctuations in commodity prices and changes in energy export volumes have a direct influence on the performance of Saudi stocks.

3. Performance Relative to Other Markets : Historically, the KSA ETF has shown strong performance compared to some emerging market ETFs. However, its heavy allocation to specific sectors, like banks, indicates a higher correlation with certain industry-specific ETFs, potentially reducing its diversification advantages????.

Conclusion

The iShares MSCI Saudi Arabia ETF offers a unique investment perspective, granting access to Saudi Arabia's vibrant equity market amidst its considerable economic overhaul. By mirroring the MSCI Saudi Arabia IMI 25/50 Index, this ETF not only broadens geographical investment horizons but also allows investors to engage with the Kingdom’s diversifying economy, increasingly moving away from its conventional reliance on oil.

Saudi Arabia's Vision 2030, with its array of mega-projects and initiatives, underscores a commitment to diversify and strengthen the economy, creating a backdrop that could favor KSA ETF investors. Following a thorough valuation analysis, the ETF emerges as a compelling investment option for 2024 and the years following. Its strong historical performance and apparent undervaluation relative to a hypothetical U.S. ETF with a similar sector composition suggest an attractive investment. Nevertheless, potential investors should carefully consider the risks, including the evolving nature of regional geopolitics, the shifting dynamics of global energy markets, and the inherent challenges accompanying Saudi Arabia’s economic reform efforts.

Editor's Note: This article was submitted as part of Seeking Alpha's Top 2024 Long/Short Pick investment competition , which runs through December 31. With cash prizes, this competition -- open to all contributors -- is one you don't want to miss. If you are interested in becoming a contributor and taking part in the competition, click here to find out more and submit your article today!

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