NORW - NORW: Skip Norway Ahead Of Further Monetary Tightening

2023-06-20 11:16:16 ET

Summary

• The Global X MSCI Norway ETF has gained some reprieve this month on the back of resilient economic data.
• But the monetary tightening cycle is far from over and will weigh on equity valuations near-term.
• With more negative EPS revisions on the horizon, the current ~11x P/E for NORW isn't appealing.

Data out of Norway has come in better than expected since I last covered the Global X MSCI Norway ETF ( NORW ), and the fund has bounced off its May lows as a result. While the long-anticipated recession may no longer be on the cards this year amid resilient consumption, investment, and export data, inflation remains a major issue. Even with energy prices easing, labor market tightness post-COVID has kept wage pressures' sticky', while the weak krone has further added to the core inflationary impulse. As a result, the Norges Bank (i.e., the Norwegian central bank) looks set to deliver more interest rate hikes than anticipated, which will weigh on equity valuations near-term before hitting household income later next year (assuming monetary policy works with a few months' lag). Structurally, the Norwegian equity market also suffers from two key headwinds - its limited depth and breadth (vs. the UK and Europe), as well as its dependence on hydrocarbon, which limits its appeal to ESG flows. At ~11x P/E for a group of Norway large-caps headed for more negative earnings revisions ahead, NORW doesn't screen attractively here.

Fund Overview - Low-Cost Exposure to a Relatively Concentrated Norwegian ETF

The US-listed Global X MSCI Norway ETF tracks, before expenses, the total return (i.e., the yield and price performance) of the MSCI Norway IMI 25/50 Index, comprising large, mid, and small-cap Norwegian equities spanning ~99% free float-adjusted market cap of the market. The ETF held ~$58m of net assets at the time of writing - well below the ~$73m prior, as a result of the fund's underperformance over the last year and investor outflows. The expense ratio is, however, maintained at 0.5%, making NORW a cost-effective option available for investors looking to express a single-country view of Norway. A summary of key facts about the ETF is listed in the graphic below:

The fund is now spread across 72 holdings (two more than in prior reporting), while the largest sector allocation, Energy, has been reduced by >1%pt to 30.1%. Financials remain unchanged at 19.9%, while Consumer Staples has replaced Materials as the third-largest holding at 14.0%. While the fund now has a slightly larger consumer allocation at 14.7% (vs. ~13% prior), its exposure remains limited relative to comparable European funds. On a cumulative basis, the top five sector concentration remains at ~87%, making NORW a relatively top-heavy single-country ETF from a sector perspective. Due to its energy-focused sector exposure, the fund's equity beta remains elevated at 1.19 to the S&P 500 ( SPY ) and 1.25 to the MSCI EAFE ( EFA ), which tracks developed markets ex-North America.

The energy-focused single-stock portfolio is also broadly unchanged relative to the prior quarter. The ETF's largest holding, state-owned energy company Equinor ASA ( EQNR ), has seen its portfolio contribution rise to 18.2% of net assets (up from ~17% prior). In contrast, other key energy holdings like aluminum and renewable energy company Norsk Hydro ( OTCQX:NHYDY ) and oil exploration and development company Aker BP ASA ( OTCQX:AKRBF ) have seen their portfolio contributions cut to 5.8% and 4.7%, respectively. The fund's main financials holdings have done well amid further rate hikes, led by financial services leader DNB Bank ASA ( OTCPK:DNBBY ) at 10.9%. Majority state-owned telecom Telenor ASA ( OTCPK:TELNF ) also remains in the top five at 4.7%. In total, the five largest holdings contribute ~44% of the overall portfolio, making NORW a relatively concentrated Nordic ETF from a single-stock perspective.

In line with the positive economic data out of Norway over the last month, NORW has seen its underlying earnings and book valuation multiples rise to 10.8x (up from 9.1x prior) and 1.8x (up from 1.6x prior), respectively. Yet, the portfolio return on equity has also dipped to 16.6% (down from ~18% prior), in line with the energy downcycle globally. With the NORW portfolio also highly levered to cyclical sectors like energy, currently going through material downward earnings revisions, lower valuation multiples seem warranted at this stage of the cycle.

Fund Performance - Underwhelming Through-Cycle Appreciation

On a YTD basis, the ETF has declined by 1.0% and has compounded at an unimpressive 1.4% rate in market price and NAV terms since its inception in 2010. The fund's dependence on the cyclical energy and materials sectors (in line with the broader Norwegian economy) is reflected in its volatile performance. The one-year annualized return, for instance, stands at -21.4% amid the ongoing energy downcycle globally, retracing most of the fund's post-COVID outperformance. On a three-year basis, NORW has still annualized at a strong 17.3%, though this shrinks materially on a five and ten-year basis to 0.4% and 0.9%, respectively. In comparison, key Nordic comparable, the iShares MSCI Sweden ETF ( EWD ), has posted annualized returns of +5.3% and +4.7% over similar five and ten-year timeframes while maintaining lower volatility.

The income-based semi-annual distribution, funded mainly via the fund's holdings in cash-generative market leaders in financials, energy, and materials, stands at a solid ~3% trailing twelve-month yield, making NORW one of the higher-yielding Nordic ETFs. That said, the income is influenced by the elevated cyclicality in its end markets; with the global energy downcycle weighing on the portfolio's underlying cash generation, the 30-day SEC yield has shrunk materially and looks set to underperform last year's $1.03/share distribution.

Skip Norway Ahead of Further Monetary Tightening

Recent economic data out of Norway has been stronger than expected, signaling the country may well be on track to avoid a potential recession this year. But a more resilient economy doesn't necessarily bode well for equities, particularly with the Norges Bank still focused on taming 'sticky' core inflationary pressures from a tight labor market and continued weakness in the FX. Expect more interest rate hikes in the coming months; as monetary policy works with a lag, higher interest rates in June and August will likely hit household incomes next year or so, presenting headwinds to the post-2023 private consumption and GDP growth path. At ~11x P/E following a wave of negative revisions this year, largely focused on the energy sector (NORW's largest exposure at ~30%), the ETF seems fairly priced. And with mid to long-term ESG flow headwinds from Norway's hydrocarbon dependence as well, I don't see much valuation upside from here.

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