QAT - QAT: Cyclical Headwinds Weigh On The Qatar Outlook

2023-06-02 06:58:40 ET

Summary

• Qatar, like the rest of the Gulf, tends to track the O&G cycle, so the recent downcycle doesn't bode well for its prospects.
• The financials-heavy iShares MSCI Qatar ETF portfolio faces additional headwinds from the government's de-levering efforts.
• The QAT valuation and yield may look appealing on a trailing basis but heading into a period of potential negative revisions, I would remain sidelined.

Weak O&G prices and a gradual shift in the Fed's monetary policy bias have weighed on the performance of the iShares MSCI Qatar ETF (QAT) this year. While the PMI downturn post-World Cup has since recovered in the private sector, weakness in the public sector has emerged as the key near-term growth hurdle, led by slower building activity and rising borrowing costs. Over the long run, there remain ample growth opportunities, though, led by a planned +40% increase in gas capacity through 2026. If the recent 27-year LNG contract with Sinopec (the longest LNG supply agreement to date) is anything to go by, there may even be upside to the headline target.

Yet, unlike Saudi Arabia, Qatar hasn't meaningfully diversified its O&G revenue into the non-oil parts of the economy. Now that infrastructure growth is set to trend downward post-World Cup, this leaves growth increasingly levered to the broader O&G cycle. And while Qatar has not committed to net-zero (its stance being that natural gas exports are already playing a role in international climate change efforts), it is now the only Gulf nation not to have signed on, so pressure could ramp up ahead of COP28 this year. Any ESG-driven pullback in production capacity would be negative for growth and, perhaps even more importantly, government efforts to de-lever the elevated loan/GDP. Given the iShares MSCI Qatar ETF ( QAT ) tracks the country's performance via the banks (53.6% financials exposure), its exposure to multi-pronged headwinds via a cyclical O&G slowdown, as well as Qatar's de-leveraging efforts means more downside could be on the horizon.

Fund Overview - Low-Cost Exposure to a Financials-Heavy Qatar Portfolio

The US-listed iShares MSCI Qatar ETF seeks to track, before fees and expenses, the performance of the MSCI All Qatar Capped Index, comprising securities in the broad Qatar equity universe (minimum of 25 securities) subject to concentration constraints (e.g., no single constituent >25% of the index weight). The ETF held ~$71m of net assets at the time of writing and charged a 0.6% expense ratio, making it a cost-effective option for US investors looking to express a single-country view of Qatar. A summary of key facts about the ETF is listed in the graphic below:

The fund is spread across 33 holdings, with the largest sector allocation (by far) being Financials at 53.6%, followed by Industrials at 12.3% and Energy at 9.3%. Three other sector exposures are above the 5% threshold, namely Materials (7.7%), Communication (5.6%), and Real Estate (5.5%). On a cumulative basis, the top five sectors accounted for ~89% of the total portfolio, making QAT one of the more concentrated Gulf state ETFs from a sector perspective. In line with the financials-heavy exposure, the fund's equity beta is relatively low at 0.34 (vs. the S&P 500 (SPY)), reflecting the defensiveness of its portfolio.

The single-stock composition reflects the fund's concentration in the financials sector, with four of the top-five names operating in the commercial banking space. The largest holdings remain the country's leading commercial bank Qatar National Bank (QNBC), and its largest Islamic bank, Qatar Islamic Bank, at 22.2% and 10.3%, respectively. The largest non-financial holding is petrochemicals, fertilizers, and steel conglomerate Industries Qatar at 6.4%. Private banks Commercial Bank of Qatar (CBQRL) at 5.5% and Masraf Al Rayan at 4.4% round up the top-five list. With the top five holdings accounting for ~49% of the overall portfolio, QAT screens as highly concentrated, even from a single-stock perspective.

Fund Performance - Strong Yield but Limited Through-Cycle Capital Appreciation

On a YTD basis, the ETF has been flat, with the rally over the last month erasing much of the post-January losses. Zooming out, the fund has generated little value for shareholders at a total annualized return of +0.1% in market price terms since its inception in 2014. After accounting for taxes on distributions and fund share sales, however, the annualized return drops to -0.6% (-1.3% assuming no fund share sales). Despite the low beta, the fund hasn't been immune from outsized moves in recent years - last year saw a -5.9% drawdown following two consecutive years of positive returns (+13.9% in 2021 and +5.9% in 2020), with 2018 experiencing the largest total return at +22.6%. Much of the fund's outperformance has been front-end-weighted, however (+11.2% three-year annualized return and +5.8% on a five-year basis), as periods of energy price weakness have tended to drive downward pressure on QAT's overall returns.

The semi-annual distribution has been a key highlight, with last year's record high distributions driving a 4.8% trailing twelve-month yield (4.3% thirty-day yield). Digging deeper, QAT's payout has generally been income-driven, closely tracking the underlying earnings of its cash-generative holdings. While the current trailing yield screens attractively relative to other emerging market ETFs, the strength of last year's payout is unlikely to be repeated this year. Not only are energy and commodity prices down, but the Qatar government is also in the midst of de-levering (i.e., lowering private debt/GDP, currently near 150% ), which will weigh on lending activity and interest margins. So even with the fund trading at a seemingly cheap ~1.1x P/B valuation, the prospect of slower earnings growth as we enter an economic/banking downcycle means the re-rating potential is likely limited from here.

Cyclical Headwinds Weigh on the Qatar Outlook

Given Qatar's ties to the O&G cycle, the latest downturn has understandably led to QAT underperforming in Q1. Unlike many other Gulf nations, Qatar has made less of an effort to diversify its revenue streams (last year's World Cup aside) - a weakness that could become even more glaring as the event-driven tourism and construction boom fades this year. While Qatar's long-term efforts to build production capacity (e.g., the planned 40% increase in gas capacity by 2026) are commendable, the ESG hurdles may be underestimated here. As the only Gulf nation not to have committed to a net-zero pledge, pressure will only mount for it to join in, and any resulting cutbacks will weigh on growth. For the banks, QAT's main sector exposure, net interest margins will be vulnerable to the government's de-levering efforts (on the macro side and via the banks' dependence on government business), as well as the Qatar Central Bank's rebalancing targets (i.e., terming out funding positions and shifting toward domestic funding sources). The ~10x trailing P/E (~1.1x P/B) is undemanding, but ahead of potential negative revisions in the coming months, I would be sidelined.

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