Saudi All Industries Sector
All Industries –All Sectors
Saudi Arabia
17 May 2015
January 18, 2010
Pritish K. Devassy, CFA
ARC Research Team
Tel +966 11 211 9370, [email protected]
Key themes
Qualified foreign institutional investors (QFI) can
directly invest in the Saudi Arabian Equity market
from 15 June 2015. In this report we look at the main
timelines, rules, opportunities, concerns for QFIs etc.
We also look at the ownership structure of the Saudi
market, valuations and the recently announced
MSCI Saudi index.
Saudi Arabia: Market opening to QFIs
Frequently Asked Questions
As the Saudi Arabian equity market opens its doors to qualified foreign
institutional investors (QFIs) for direct ownership, we look at some of the
frequently asked questions by investors. Topics discussed are timelines, final
rules, opportunities, concerns for QFIs etc. We also look at the current
ownership structure of the Saudi market, valuations and the recently
announced MSCI Saudi index.
When is the Saudi Arabian market going to open to foreign investors?
The Saudi Council of Ministers announced in late July last year that qualified
foreign institutional investors will be allowed to invest directly in the Kingdom’s
equity market. Accordingly, the Capital Market Authority (CMA) published its
draft rules on August 21, 2014 for consultations giving market participants and
interested parties ninety days. The market regulator published its final
regulations for QFIs on May 4, 2015. The rules will come into effect from June 1,
2015 and the QFIs will be permitted to invest in the Tadawul-listed companies
beginning June 15, 2015.
What are the final rules? Have there been any changes to the draft
published earlier?
No, there were no major changes in the final QFI rules compared to the draft
rules. Some of the key highlights of the final rules are stated below:

Only financial institutions (banks, brokerages & securities firms, fund
managers, insurance companies) with appropriate license and regulatory
approvals will be considered as QFIs.

The QFI should be engaged in investment business for a minimum period of
five years.

The QFIs should have a minimum of SAR18.75bn (US$5bn) assets under
management, although the CMA may reduce it to SAR11.25bn (US$3bn) at
its discretion.

Each QFI, together with its affiliates, or each approved QFI client together
with its affiliates may own a maximum of 5% of any issuer’s shares.

The maximum proportion of the shares of any issuer whose shares are listed
that may be owned by all foreign investors (in all categories, whether
residents or non-residents) in aggregate is 49%, including interests under
swaps. (E.g. In some of the banks where foreign strategic investors hold
~40%, only 9% stake is left for QFI and QFI clients including swaps).

The maximum ownership in any issuer by QFIs and approved QFI clients is
20%.

The maximum proportion of the shares of all issuers whose shares are listed
that may be owned by QFIs and approved QFI clients in aggregate is 10% by
market value, including any interests under swaps.

There is no mention of a capital gains tax. However, a 5% withholding tax on
dividend distributions will apply.

A QFI cannot engage with more than one “Assessing Authorised Person” at
the same time.
Disclosures Please refer to the important disclosures at the back of this report.
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17 May 2015
What opportunity does it bring in for the foreign investors?
Saudi Arabia is one of last major markets to open to foreign investors and presents a huge
potential to investors scouting for growth opportunities in the emerging market space. Saudi
Arabia in particular has the advantage of pegged currency (to USD), which significantly
reduces currency related risks considering the volatility in emerging market currencies.
Foreign investors currently can invest in the Tadawul mostly via swaps, which gives them no
direct ownership rights that too at higher trading costs. The QFI route provides a foreign
investor with full ownership rights and allows him to actively participate in the market at
significantly lower costs (trading costs 12bps) . With the active participation of QFIs and
increasing institutionalization of the market, transparency and disclosure practices of the
listed companies are likely to be improved. Foreign investors will benefit from the local
market’s correlation with oil prices, which can offset their risk exposure to other emerging
markets. Domestic investors are likely to benefit from increased market depth and improved
corporate governance.
What are some concerns for QFIs?
Based on our understanding and interactions with some investors who have shown
willingness to invest in the Saudi Arabian equity market, we highlight some of their concerns:
 Few mature sectors: Although Tadawul is the largest stock market in the GCC region,
three major sectors – Petrochemicals, Banking and Telecom –account for over 60% of
Tadawul’s market cap of ~US$570bn. Remaining 12 sectors, largely comprising of mid and
small companies, account for the remaining 40% of the market. Nevertheless, some of the
these mid and small cap companies are fundamentally solid companies benefitting from
the Kingdom’s investment drivers such as increasing disposable income, favourable
demographics, increased government spending on social sectors etc.
 Dependence on oil and oil related sectors: Although the Saudi Arabian government
has been working on the Kingdom’s economic diversification, the oil-related Petrochemical
sector continues to be extremely important to the economy. Government has supported the
sector through allocation of feedstock at subsidized prices as well as providing loans.
Further, Saudi Arabian government derives ~90% of its revenues from oil, indicating its
high dependence on oil. A volatile oil market, as seen over the past few quarters can
dampen investor’s view on Kingdom’s growth and increase market volatility.
 Valuation Concerns: Saudi Arabian benchmark index (TASI) is currently trading at a
forward PE of 16.7x (2015E), well ahead of its emerging market peers – India (15.5x), Brazil
(15.3x) and Russia (7.1x) (Source: Bloomberg).
 Geopolitical concerns: In spite of political stability within the Kingdom, the broader
regional geo-political concerns in the Middle East ( e.g. Arab Spring, Egypt unrest, Syria,
Yemen) can impact investor sentiment.
Is 10% too less for foreigner ownership limits?
Despite being open to foreign investors for several years now, only 4 out of the more than 40
stocks listed on the Qatar Exchange have more than 10% foreign ownership. In the UAE, the
foreign ownership in 13 UAE-based companies listed on the Dubai Financial market have
more than 10% ownership out of a total of 55 stocks. Similarly, mainland China had
ownership limit of less than 1% of total market capitalization till 2012. Thus, we do not
believe that a 10% foreign ownership limit is too less to begin with. Nevertheless, this limit is
expected by investors to be raised gradually in the future.
Oil prices have fallen sharply over the last couple of quarters and widely expected to
remain subdued in the near future. How will it impact investor confidence?
Despite the lower oil prices, the Saudi Arabian government has maintained its commitment
towards high spending with a focus on developing its infrastructure in order to diversify the
economy away from the oil sector. The Kingdom has foreign currency assets of ~US$690bn,
which can be used in case of subdued oil prices. In addition, oil prices have improved slightly
(~19% YTD) on the back of a rebalancing in the demand-supply dynamics. Currently trading
Disclosures Please refer to the important disclosures at the back of this report.
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Saudi All Industries Sector
All Industries –All Sectors
17 May 2015
at ~US$67 a barrel, long term trend is likely north bound and should be positive for the Saudi
Arabian economy and capital markets.
What is the regulator’s (CMA) key focus with regards to the market opening?
Few of the key objectives of the CMA are to see increased institutional participation over the
coming years, add expertise of financially sophisticated foreign investors that would benefit
the local market and reduce volatility in the market, among others. The CMA is taking several
steps to raise awareness on capital market and equity investments.
Do valuations look expensive currently?
The Saudi Arabian benchmark index (TASI) has surged ~17.3% YTD, on the back of the
impending opening up of the Kingdom’s equity market and recovery in oil prices, surpassing
that of its GCC peers – Dubai (+10%), Abu Dhabi (+3%), Oman (-0.3%) and Qatar (-1%). The
TASI is currently trading at a PE (12 months trailing) of 20.5x and PE (12 months forward) of
16.7x. This is owing to the increased optimism in view of the market opening.
Figure 1 TASI 12-month forward PE multiple over the last five years
17.0x
16.0x
15.0x
14.0x
13.0x
12.0x
11.0x
10.0x
9.0x
Jan-15
Mar-15
Nov-14
Jul-14
Sep-14
May-14
Jan-14
Mar-14
Nov-13
Jul-13
Sep-13
May-13
Jan-13
Mar-13
Nov-12
Jul-12
Sep-12
May-12
Jan-12
Mar-12
Nov-11
Jul-11
Sep-11
May-11
Jan-11
Mar-11
Nov-10
Jul-10
Sep-10
May-10
8.0x
Source: Bloomberg, Al Rajhi Capital
When is the MSCI likely to include Saudi Arabia in its emerging markets index? What
are the rules and will there be a swifter process?
The opening up of the Saudi Arabian market will initiate the process of inclusion of the Saudi
Arabian equity market in various relevant indices based on its review process. However as
per MSCI, the inclusion in a MSCI Index (frontier or emerging) would take around two years.
It is expected that Saudi Arabia is likely to have a 1.5-2.0% weight in the emerging market
index based on the current status.
Generally, a country is first included in the frontier market index and it is later upgraded to
an emerging market status. However, due to the significant size of the Saudi Arabian market,
the country is likely to be given an emerging market status from the beginning itself with a
likely inclusion in the MSCI Emerging Market index. If included in the frontier market index,
the Kingdom may have a weight of 63%, while it will only have a weight of 1.5-2.0% in the
emerging market index. As per MSCI, there is approximately US$1.7tn tracking the MSCI EM
Index and an approximate weight of 1.5% indicates ~US$25bn is likely to flow into the Saudi
Arabian market, which is over 4.4% of the TASI’s total market cap.
Disclosures Please refer to the important disclosures at the back of this report.
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Saudi All Industries Sector
All Industries –All Sectors
17 May 2015
How much stake do foreigners currently have in the domestic market?
Foreigners can currently participate in the Tadawul only through swaps and exchange traded
funds. Currently retail ownership is 35% while institutional holding is ~60%. Based on CMA’s
published report (H2 2014 semi-annual statistical bulletin), foreigners own around 1% of the
market via swaps.
What was the impact of market opening in the regional markets?
Saudi Arabia is one of the last major markets in the world to open to foreign investors. UAE
and Qatar are the only two markets in the region, which are given emerging market status by
the MSCI. The UAE markets were open to foreign investors since its beginning, while Qatar
was opened to foreign investors later in 2005. The Qatari market saw increased volatility
following the market liberalization announcement. The Qatar Exchange index jumped from
the 4,000 levels in January 2004 to around 13,000 levels by late 2005, before eventually
falling back to the 8,000 levels by early 2006. However, after the initial volatility subsided,
the market recovered its upward trend. Nevertheless, most of the regional markets during
this period had become extremely expensive, leading to sharp correction during this period.
In the Kingdom, TASI had touched a peak of more than 20,600 in February 2006, which
eventually corrected to a low of around 6,900 in January 2007.
The Saudi Arabian market witnessed a sharp rally during 2014 gaining ~15% after the market
liberalization announcement. Nevertheless, the market pared the gains as the overall
sentiment weakened following the sharp drop in oil prices during the last quarter of the year.
What was the impact of market opening in other emerging markets?
China opened its main A-share market to QFIIs in late 2002. However, due to high
requirements to be a QFII (US$5bn minimum AUM and at least 5 years of operation) and
strict ownership restrictions of US$20bn and a maximum of US$1bn per institution, the
country did not witness much foreign investor interest. Till 2012, foreign investor
participation in A-shares was restricted to US$30bn, less than 1% of total market
capitalization, and only US$25bn was utilized. As a result of the strict restrictions, the MSCI
did not consider including China A-shares in the MSCI EM Index. However, the country has
accelerated financial sector reforms over the last couple of years, and MSCI is currently
reviewing the inclusion of A-shares in the MSCI EM Index. As a result of foreign investors
entering the Chinese market, retail investor participation in the trading has come down from
90% in 2003 to 60%. However, it still remains high compared to India (34%) and US (less
than 2%).
Which sectors are QFIs likely to be interested in?
It is not easy to generalize or single out any specific sector/stock but attractiveness of a stock
will depend on its valuations and diversity it brings to the investor’s portfolio. We believe the
petrochemical companies such as SABIC will give foreign investors exposure to the biggest
petrochemical company in the Kingdom, which has subsidized fuel costs. The consumer and
the banking sectors are likely to be favoured by investors who are interested in the domestic
and consumer based growth story. Some companies in the retail and food sectors such as
Jarir and Almarai respectively could be viewed favourably given the strong fundamentals and
higher transparency.
With the equity market opening up, do we see derivative trading being introduced?
The CMA has been undertaking strong efforts to create a more efficient and developed stock
market, bringing it in line with the developed markets. We do not see the introduction of
derivative instruments over the near-term due to their complex nature. We believe the next
step is towards introducing more products on the fixed income side (government and
corporate bonds etc.).
Disclosures Please refer to the important disclosures at the back of this report.
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All Industries –All Sectors
17 May 2015
Can QFIs invest in IPOs?
Technically, QFIs are not barred from investing in IPOs by the CMA. However, QFIs and
approved QFI Clients participation in IPOs are taken looking at each company’s case
separately.
Does Saudi Arabia require foreign capital?
Saudi Arabia is the largest and the richest country in the region. A large IPO as that of NCB in
late 2014 (US$6bn), was oversubscribed by 23 times, which indicates the depth of the local
capital market and ability to raise such capital. However more importantly
institutionalization of the Saudi Arabian market is a positive development for the Kingdom’s
capital markets and will help economic growth eventually.
How will foreign fund flow impact volumes?
Trading volumes are likely to gradually increase after the opening up of the Tadawul to
foreign investors. Trading volumes are usually low during the holy month of Ramadan
(corresponding to mid-June to mid-July this year) and summer. However, foreign capital
inflow is likely to result in higher volumes during this usually low participation period as local
investors are likely to participate more actively during this period.
What are the major stocks in the MSCI Saudi Arabia Domestic Index?
MSCI plans to launch MSCI Saudi Arabia Indexes as Standalone Market Indexes effective
June 1, 2015. The MSCI Saudi Arabia Index will have 19 constituents, while the MSCI Saudi
Arabia Small Cap Index will have 39 constituents. We list the companies that will form part
of both the indices. (See Figure 2 - Please note that percentages do not add up to 100%
because of rounding of values. Source - Reuters).
Disclosures Please refer to the important disclosures at the back of this report.
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Saudi All Industries Sector
All Industries –All Sectors
17 May 2015
Figure 2 MSCI Saudi Arabian market indices constituents
MSCI Saudi Arabia Index
Companies to be included in the MSCI
Saudi Arabia small cap index
Weight
1 Al Rajhi Banking & Inv
2 Al Tayyar Travel Group
8%
1 Abdul Mohsen AlHokair
2%
2 Abdullah Al Othaim Mkt
3 Alinma Bank
4 Almarai Co
3%
3 Advanced Petrochemicals
4%
4 Al Abdullatif Indl Inv
5 Arab National Bank
6 Banque Saudi Fransi
3%
5 Al Hammadi Development
4%
6 Al Jouf Cement
7 Etihad Etisalat Co
8 Fawaz Abdulaziz Alhokair
2%
7 Al Mouwasat Medical Svcs
2%
8 AlHassan G.i. Shaker Co
9 National Comm Bank
10 Rabigh Refining & Petro
10%
9 Arabian Cement (Sa)
2%
10 Arriyadh Construction
11 Riyad Bank
12 Samba Financial Group
4%
11 Aseer
5%
12 Astra Industrial Group
13 Saudi Arab Fertilizer
14 Saudi Arabian Mining Co
4%
13 Bawan
4%
14 Bupa Arabia For Copr Ins
15 Saudi Basic Ind Corp
16 Saudi Electricity Co
23%
6%
16 Co For Cooperative Ins
17 Saudi Telecom Co
18 Savola
11%
17 Dallah Healthcare Hldg
19 Yanbu Natl Petrochemical
15 City Cement
3%
18 Dur Hospitality
2%
19 Eastern Province Cement
20 Hail Cement
21 Herfy Food Services
22 Mediterranean & Gulf Ins
23 Najran Cement
24 National Agri Dev (The)
25 National Medical Care
26 Northern Region Cement
27 Red Sea Housing Svcs Co
28 Saudi Ceramic
29 Saudi Chemical Co
30 Saudi Dairy & Foodstuff
31 Saudi Marketing
32 Saudi Pharmaceutical Ind
33 Saudi Public Transport
34 Saudi Real Estate Co
35 Tabuk Cement Co
36 The Qassim Cement Co
37 United Electronics
38 United Intl Transport
39 Zamil Industrial Inv
Source: Reuters, Al Rajhi Capital
Disclosures Please refer to the important disclosures at the back of this report.
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Saudi All Industries Sector
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17 May 2015
Disclaimer and additional disclosures for Equity Research
Disclaimer
This research document has been prepared by Al Rajhi Capital Company (“Al Rajhi Capital”) of Riyadh, Saudi Arabia. It has been prepared
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Additional disclosures
1. Explanation of Al Rajhi Capital’s rating system
Al Rajhi Capital uses a three-tier rating system based on absolute upside or downside potential for all stocks under its coverage
except financial stocks and those few other companies not compliant with Islamic Shariah law:
"Overweight": Our target price is more than 10% above the current share price, and we expect the share price to reach the target
on a 6-9 month time horizon.
"Neutral": We expect the share price to settle at a level between 10% below the current share price and 10% above the current
share price on a 6-9 month time horizon.
"Underweight": Our target price is more than 10% below the current share price, and we expect the share price to reach the target
on a 6-9 month time horizon.
2. Definitions
"Time horizon": Our analysts make recommendations on a 6-9 month time horizon. In other words, they expect a given stock to reach
their target price within that time.
"Fair value": We estimate fair value per share for every stock we cover. This is normally based on widely accepted methods
appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis.
"Target price": This may be identical to estimated fair value per share, but is not necessarily the same. There may be very good
reasons why a share price is unlikely to reach fair value within our time horizon. In such a case we set a target price which differs
from estimated fair value per share, and explain our reasons for doing so.
Please note that the achievement of any price target may be impeded by general market and economic trends and other external
factors, or if a company’s profits or operating performance exceed or fall short of our expectations.
Contact us
Pritish Devassy, CFA
Senior Research Analyst
Tel : +966 11 211 9370
Email: [email protected]
Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No. 07068/37.
Disclosures Please refer to the important disclosures at the back of this report.
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