KSA - KSA: Fairly Priced

2023-12-13 02:26:37 ET

Summary

• The iShares MSCI Saudi Arabia ETF provides access to Saudi Arabian equities. Saudi Arabia's economy has some promising growth prospects built around its young population and diversification away from oil.
• However, the KSA ETF is heavily concentrated, with the top 10 holdings accounting for 56% of the portfolio and Financials accounting for 40% of the fund.
• With the KSA ETF trading at a 16.4x P/E, Saudi Arabian equities as represented by the KSA looks fairly priced.

Following up on my recent article on broad Emerging Market equities, this article examines the iShares MSCI Saudi Arabia ETF ( KSA ), an ETF dedicated to Saudi Arabian equities.

Saudi Arabia Overview

Saudi Arabia is the largest economy in the Middle East with a GDP of $1.1 trillion, ranking it 17th largest in the world. Historically, Saudi Arabia's economy was highly tied to the production of hydrocarbons due to Saudi Arabia's leading role in OPEC, the group that produces ~30% of the world's crude oil. Saudi Arabia is the largest oil producer within OPEC and has traditionally been the group's de facto leader.

However, since the mid-2010s, Saudi Arabia has been actively trying to diversify its economy away from hydrocarbons with some promising success, as hydrocarbons' share of GDP has fallen from ~50% in the early 2000s to just over 20% recently (Figure 1).

In particular, in recent years, Saudi Arabia has rolled out a vision for a radical transformation of the Saudi economy to reduce its dependence on oil and stimulate non-oil sectors. As part of this plan, Saudi Arabia plans to boost non-oil exports to over 50% of GDP and the private sector contribution to more than 65% of GDP with a focus on industries such as tourism, entertainment, technology, and renewable energy. (Figure 2).

Recent investments by Saudi professional football teams to bring top-level footballers like Neymar and Christiano Ronaldo to play in the Saudi Arabia Professional League is part of this focus on entertainment, as well as the creation of the LIV Golf tour in direct competition with the established PGA tour.

However, it remains to be seen whether these investments will eventually bear fruit, as we also saw a wave of Chinese trophy investments into European football clubs a decade ago that have mostly fizzled.

More promising for investors is the Saudi government's push to privatize state-owned assets, including major companies in sectors like energy, water, and telecommunications. As these companies go public, there will be opportunities for investors to participate in the privatization process and gain exposure to well-established, revenue-generating entities.

Saudi Arabia also has a large and youthful population, with a significant portion of the population under 30 years old (Figure 3).

This attractive demographic distribution, combined with rising income levels, could lead to strong growth in consumer spending and may benefit companies focused on this growing middle class.

Fund Overview

The iShares MSCI Saudi Arabia ETF provides investors convenient access to a broad-based index of Saudi Arabian equities.

The KSA ETF has $737 million in assets and charges a 0.74% expense ratio (Figure 4).

Portfolio Holdings

As mentioned at the beginning of this article, the Saudi Arabian economy has been trying to diversify away from hydrocarbons and this change is evident in the makeup of the KSA ETF, as Energy only represents a relatively small 8.6% of the fund (Figure 5). The largest weights are actually Financials (40.0%), Materials (19.4%), and Communication (9.0%).

However, the KSA ETF is still fairly concentrated, with the top 10 holdings accounting for 56% of the portfolio (Figure 6). 5 of the top 10 holdings of the KSA ETF are banks.

Also, it is notable that Saudi Arabian Oil ("Saudi Aramco"), despite being one of the largest companies in the world with over $2 trillion in market capitalization, only has a relatively small 7.5% weight in the KSA ETF (Figure 7).

If the KSA ETF was naively market cap weighted, Saudi Aramco would account for more than 70% of the ETF, as the entire market capitalization of Saudi Arabian equities is only $2.9 trillion, including Saudi Aramco (Figure 8).

Distribution & Yield

The KSA ETF pays a semi-annual distribution with a trailing 12-month yield of 2.2% (Figure 9).

Returns

Historically, the KSA ETF has performed well, returning 10.1% and 8.9% on a trailing 3- and 5-year basis to November 30, 2023 (Figure 10).

This has vastly outperformed the iShares MSCI Emerging Markets ETF ( EEM ), which has returned -4.8% and 1.6% in the same timeframes (Figure 11).

In fact, due to KSA's heavy allocation to banks, the KSA ETF has a higher correlation to the Financial Select Sector SPDR Fund ETF ( XLF ) than the Energy Select Sector SPDR Fund ETF ( XLE ). In the past 3 years, the KSA ETF has traded in virtual lockstep with the XLF ETF, delivering 34.9% in total returns compared to XLF's 34.5% (Figure 12).

KSA Valuation Is Inline With The World

Looking forward, with the KSA ETF trading at a trailing P/E ratio of 16.4x, Saudi Arabian equities do not look particularly attractive (Figure 13), as the MSCI All Country World Index is trading at 16.0x Fwd P/E (Figure 14).

Furthermore, given the high correlation between the KSA and XLF ETF, the KSA ETF may not provide many diversification benefits for domestic U.S. investors.

I believe the KSA ETF may become more interesting as Saudi Arabia's diversification plan comes to fruition later in the decade with more diverse companies included in the ETF. However, for now, with its heavy concentration in fairly priced financials, I do not find the KSA ETF attractive.

Conclusion

The iShares MSCI Saudi Arabia ETF provides access to Saudi Arabian equities. Although I am bullish on a turnaround in Emerging Equities heading into 2024, the KSA ETF would not be my first choice, as the valuations of the KSA ETF are in line with the rest of the world and it is heavily concentrated in Financials.

I rate the KSA ETF a hold .

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