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Saudi Strategy - Adjusting exposure after 11% run; stay OW

Our base case implies 10% upside, bull case offers 30%

Since our notes on 25 and 27 Feb, when we called for another 21% upside in Saudi Arabia, the Tadawul index has surged 11% (outperforming EM by 7% and MENA-x-KSA by 5%). Our base case assumes that the Tadawul hits a 5-year peak TTM P/E of c23x (vs 21x now), implying c10% upside. However, if Tadawul’s P/E expands (vs historical avg.) by 50%, which is the avg. of what we saw in the UAE/Qatar/Pakistan upgrade events, then we see c30% upside (bull case scenario). Overall, we remain bullish on Saudi Arabia and barring i) any sharp corrections in oil prices; ii) renewed negative political news flow; or iii) local institutions/GREs leaning heavily on the market, we expect Tadawul to end-2019 on a high note. We do not expect a major pullback as seen in the UAE/Qatar in 2014 and Pakistan in 2017. As a reminder there are cUSD1bn inflows from FTSE trackers on 30 Apr and USD6bn inflows from MSCI trackers on 28 May. An additional cUSD10.5bn inflows will come after May. 
Reshuffling our portfolios and baskets ahead of the May trade

We remove SAMBA, ZAINKSA, BUDGET, AOTHAIM, YANSAB, and ALMARAI from our Saudi portfolio (fig.1) (with BUDGET, AOTHAIM, YANSAB, and ALMARAI also cut from our MENA Top 20 list as well). Instead we add LEEJAM, SCERCO, HERFY, SIPCHEM, and ALAWWAL (with LEEJAM, EXTRA, SIPCHEM and ALAWWAL joining our MENA Top 20 list as well). With regards to our top 10 plays (fig.2) on flows, which we recommended on 25 Feb (+10% since), we remove YANSAB, SECO, and add SIPCHEM (as a play on a potential M&A-driven MSCI addition) and ALAWWAL (as a play on SABB’s flows at a 4.8% discount to the agreed share swap ratio). 

LEEJAM offers unique exposure to KSA’s underpenetrated fitness market and we see it as a small cap addition into both MSCI and FTSE indices in May/June, respectively. SIPCHEM is a key beneficiary of rising oil prices and it is also a potential addition to MSCI Saudi Arabia Standard Index following its merger with SPC driving cUSD160mn of inflows into the name upon implementation, while it is benefiting from FTSE flows in the meantime. ALAWWAL’s multiple expansion has lagged behind other major Saudi banks (compared to 5-year avg. P/B) and its merger with SABB means it will join MSCI EM via SABB, driving incremental MSCI flows of cUSD60mn. HERFY (leading fast-food brand in Saudi) is undergoing a recovery and we see more upside. SCERCO is trading near its all-time low P/B (and below its replacement cost of SAR32/share). Catalysts for SCRECO include i) potential anti-dumping duty; ii) production disruption in Indian tile industry; and iii) improving demand from housing projects (long-term story).   

Mohamad Al Hajj