Macro Ideas: The bullish case for Saudi Arabian stock market 

By Matein Khalid
2018 is the year the world financial markets will embrace the unloved, underowned Saudi stock market, whose TASI index is down 42% since mid-2014. Why? One, the kingdom has reassumed its role as OPEC’s swing producer after it cut its output by 300,000 barrels a day, thus taking 100 million barrels a day from the global crude oil market. Saudi Arabia also brokered the 1.8 MBD output cut pact with Russia and OPEC that has ended the oil glut, engineered a rise in Brent crude from $45 last summer to $71 now and set the stage for a new petrocurrency tsunami to ease its budget deficit.
 
Two, MSCI will upgrade Saudi Arabia, the largest stock market in the Arab world in both trading volumes and market cap, to emerging markets status. This means $35 billion in index tracker funds will flow into designated Tadawul index stocks. I remember how profitable it was to own UAE and Qatari stocks ahead of their EM upgrade. Saudi Arabian equities will be no different.
 
Three, the anti-corruption crackdown in Riyadh have increased the economic power of Saudi state and fiscal austerity has been replaced by an expansionary budget. Yet the removal of petrol subsidies mean an uptick in inflation, possibly to as high as 5% on the consumer price index. Fiscal stimulus and inflation are both bullish for the Saudi stock market.
 
Four, the Saudi Aramco IPO will be one of the most awaited new listings in the international capital markets. The kingdom has also become a regular issuer of sovereign bonds and sukuk in the Eurobond market, with a $17.5 billion US dollar debt in 2016, the single largest issue in the global debt markets. The 3.8 times bid to cover ratio meant the kingdom increased the size of its issue by $2.5 billion. Saudi Arabia has also opened its local stock market to international institutional investors. The deregulation, reform and privatization program in Saudi capital markets is an integral component of the Vision 2030 plan. In fact, Saudi Arabia’s Tadawul stock exchange plans an IPO in 2018. I plan to IPO our Park Regis Makkah hotel in 2020.
 
Five, the Royal court in Riyadh announced that it will spend $261 billion in 2018, the largest ever budget in the history of the kingdom, to support its reformist agenda. Saudi Arabia will emerge from its 2017 recession in 2018. The IMF has boasted its GDP growth forecast. Saudi Arabia is also poised to dramatically increase issuance of Umra visas, making religious tourism the most lucrative property investment theme in the Middle East. Since the Saudi youth unemployment rate is 13%, fiscal stimulus and economic reforms on this scale will kick start a consumer boom. Yet the introduction of the Value Added Tax (VAT) and the sharp rise in petrol prices will have an inevitable adverse impact on disposable income, the reason for recent salary increases from the $100 billion Ritz Carlton windfall.
 
Six, Saudi Arabia wants to attract world’s technology elite to the kingdom. Amazon is planning a major cloud infrastructure investment in Saudi Arabia, while Apple plans to open a chain of stores. The kingdom’s decision to allow women to drive will have a seismic impact on its economic potential.
 
Saudi Arabia’s 2016 national transformation plan will be a game changer for the kingdom’s economy. As millions of women enter the labour market, wages will fall, as will the dependence on expatriate workers. This will boost profit margins in the kingdom. No longer will rent seeking minor princes be able to rig state contracts or inflate land prices. The cut in utility subsidies will cut extravagant wastage in electricity, while the 80% rise in petrol prices is a game changer for Saudi’s embryonic “fuel conservation” culture.
 
Vision 2030’s financial goals cannot be attained without a vibrant engaged Saudi private sector. I am fortunate enough to number so many of Saudi Arabia’s private investors among my friends and business partners. The Crown Prince needs to woo the business elite of the kingdom, from the Hadrami magnates of Jeddah to the property billionaires of Riyadh, from the bankers of Qasim to the merchant dynasties of the Eastern Province. This means tax cuts, pro-growth policies, new sunrise industries and global economic integration. I was thrilled to hear Japan’s Softbank may invest in the kingdom’s electricity sector. Saudi and global business are the natural allies of economic reform, social change and a reimagined kingdom.
 
Market View – Industrial property and the brave new world of E-commerce 
 
The rise in Treasury bond yields is unquestionably bearish for classic bond proxies such as utilities and most segments of real estate. Yet I have made no secret of my conviction that industrial real estate is the most attractive, most resilient niche in global property investing. This does not mean an investors should shell out a fortune to own a warehouse or buy a leveraged lease on an Amazon bulk warehouse with the fixed 7 – 8% returns while bearing the full risk of an industrial cycle downturn or interest rate hike. My interest lies in the industrial real estate trusts (REIT’s) in the US, Europe and Singapore which are listed on a major stock exchange, boast organic growth, seven to ten year tenant lease (which landlord in Dubai or the GCC can boast such long leases?), corporate tenants with world class brands, pricing power and, ideally, be positioned at the nodal points of the world’s evolving E-commerce infrastructure.
 
Investing in apartment/suburban malls/office REIT’s and villas is now senseless as these sectors simply lack pricing power. I am aghast at the low dividend yields, conflicts of interests (wives getting refurbishment contracts in a husband’s REIT, c’est triste!) exploitative fees and total lack of liquidity in so many REIT’s listed in Dubai and the Gulf. I cannot think of a single liquid industrial REIT to invest in the GCC. This will change as the plunge in Grade A warehouse rents will force operators/owners to rethink exit strategies.
 
My investment experience in industrial REIT investing was facilitated in 2006 by Dr. Finian Tan, former Cambridge mathematician/Goldman Singapore CEO and chairman of Vickers Financial Group, a Singaporean mini-Blackstone. I spent a week with Dr. Tan in his Suntec Tower office and his lovely Holland Road classical mansion, learning the nuances of industrial property investing in Asia. This led to a windfall deal where I helped Finian arrange financing for the IPO of Cambridge Industrial Trust on the Singapore Exchange in 2006, taking advantage of Mitsui’s decision to exit owning warehouses in Southeast Asia. The deal was highly profitable as the yield was 8.50%, the NAV doubled in the next decade and the Singapore dollar fell from 1.65 in 2006 to 1.31 now.
 
I remember that way back in 2006, Dr. Finian predicted that his good friend Jack Ma’s Alibaba would change the world. I wish I had gone to China with him when he invited me but I feared the continually expanding frontiers of my own ignorance about the Middle Kingdom. After all, the only Chinese words I use in daily life are “chop suey” and “dim sum” LOL! In life, as in the markets, the ultimate risk is when you don’t even know what you don’t know.
 
I had profiled San Fran based Prologis REIT as my favourite global logistics real estate equity as its portfolio encompasses the US, Europe, Asia and Latin America. Prologis has earnings growth embedded in its business model until at least 2023, something impossible to find in any REIT I know listed in the Middle East. With more than 800 million square feet of industrial real estate in dozens of countries on four continents, Prologis defines its property segment. Prologis generated a total return of 28% for investors who acted on my recommendation in the KT in 2016 – early 2017. With its own land bank, its established relationships with the Fortune 500 multinationals, its development prowess, Prologis sees funds from operations in the 2.85 – 2.95 range in 2018. This means Prologis can offer a total return of 15% in 2018 if investors time their entry price right.
 
I expect industrial real estate to have the lowest vacancy costs and highest total return after data centers/medical labs in the next two years. Vacancy costs in high service cost/maintenance/insurance/mortgage markets make home ownership extremely risky. Re-leasing costs are also much lower than in office, homes or, God forbid, retail. Above all, industrial property offers lower oversupply risk as build time is far quicker and sensitive to real time shifts in supply and demand. Thanks to the exponential growth of E-commerce, industrial real estate offers high liquidity as pension/sovereign wealth funds scramble to own this asset class. Even so, I can find industrial assets priced below replacement costs even in 2018. In Singapore, I am longtime fan of both Cambridge and Mapletree Logistics, the ultimate hard asset in the hardmoney Asian Swissie! Industrial real estate is also a hedge against inflation, offers positive leverage as well as uncorrelated returns with equities. This property segment is pure gold if done right.
 
Stock Pick – The Lloyds Bank strategic trade idea was a winner! 
 
I had recommended buying the shares of Britain’s Lloyds Bank in a column published on October 29, 2017. My UK banking black horse has been a real winner in the last three months. Lloyds’s New York ADR has risen from 3.50 to 4.16 as I write. I believe Lloyds can move higher as its net profits are leveraged to the sterling money market yield curve and more Mark Carney base rate hikes. In any case, Lloyds will generate excess capital even though its Basel Tier One ratio is a stellar 14.8%. This means a higher dividend and share buybacks in 2018, a mantra I adore as I am long the bank’s shares. Lloyds boasts a return on tangible equity of 16% even as lending/mortgage margins rise. As equity dilution risk falls due to excess capital generation, profitability rises and valuations are rerated.
 
The valuation of Lloyds Bank is still compelling at 9 times earnings, 0.97 times book value and 6.1% dividend yield. The acquisition of MBMNA’s UK credit and portfolio and Scottish Widow’s pension/annuity business are both growth ballasts that I believe are sustainable. Lloyds can and will outperform RBS and Barclays as its smartphone/digital banking technology backbone gooses margins and reduces cost. Even now, Lloyds boasts a 21% market share in retail banking and is the UK’s top mortgage lender. I reiterate my conviction that Lloyds shares can hit 85 pence on the London Stock Exchange (LSE).
 
Sterling’s strength has been the reason I prefer to buy Lloyd’s New York ADR (symbol LYG). I have published successive long sterling columns since the cable breakout at 1.28 late last summer. As we scale June 23, 2016 levels, sterling will trade on UK data commentator, Westminster politics/the Tory regicide index and Brexit deal making.
 
Barclays shares have been a disaster in the City of London, mired in the 180 – 200 pence range since November. Despite New York hedge fund Tiger Global’s $1 billion accumulation, the grandees of the Square Mile are skeptical about CEO Jes Staley’s plan to focus on the US investment bank, Barclaycard/UK retail banking while exiting Africa, continental Europe and the Middle East. Barclays trades at a mere 0.5 times tangible price/book, a huge discount to J.P. Morgan 2.1X or even Morgan Stanley’s 1.6X relative valuation.
 
True, there is no way I can remotely compare the franchise value, earnings power or global brand of the House of Morgan twins with the humbled Quaker High Street clearing bank transformed into Bob Diamond’s LIBOR rigging Barcap, once Britain’s only real global investment bank since the death of Sir Sigmund Warburg. Yet Barclay’s Cinderella valuation now seems compelling to me, at last relative to Wall Street names like Morgan Stanley, Citicorp and Goldman Sachs that have rerated to my target prices. Staley’s restructuring has boosted Barclay’s Basel Three capital ratios and the acquisition of Lehman’s equity franchise a decade ago will finally allow it to print money on Wall Street.
 
A steeper US Treasury debt yield curve, global M&A mania and Trump’s rollback of Dodd Frank/tax reform are all bullish for Barclays. We few, we happy few, we band of bankers, Jes Staley might have roared at the battle of Agincourt but the true mettle of his pasture will be if he restores the dividend. Nothing so depresses the cognoscenti of the City as a dividend cut, the draconian decision Barclays made two years ago. Fixed income/currencies trading is also in a malaise at Barclays, as in its New York money center banking peers and Staley is still under investigation for his ill-judged attempt to “out” a whistleblower. The 2008 capital raise in Qatar is still a live Serious Fraud Office case and legal liabilities from UK mortgage fraud misselling remains an Achilles heel for Barclays’s valuation metric. Yet my argument is that this is precisely the reason why Barclays trades at such a colossal discount to tangible book value. I know Tiger Global for Chase Coleman’s macro/E-commerce bets, for his genius in judging the world changing potential of Spotify, Airbnb and Priceline.com. This guy is the real McCoy, my Pied Piper for Barclays.
 
2017 was such a tragic year for Britain. I was in London during the Arianna Grande horror, the Grenfell Towers fire and the London Bridge terrorist attack and saw the Westminster palace attack on Sky TV. So hope 2018 is a wonderful, wonderful year for HM The Queen and all British friends in town. Jolly boating weather, what? Lads!

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