On the road in the Middle East: Saudi Arabia and Dubai
Ross Teverson, Head of Strategy, Emerging Markets
Saudi Arabia has attracted international attention recently because of the reform agenda being driven by crown prince Mohammad bin Salman. As a fund manager, my approach emphasises the opportunities created by changing situations, so Saudi Arabia was a natural choice for a research trip and gave me an opportunity to visit Dubai on the way. Dubai is home to a number of interesting companies, including one that we own in the Jupiter Global Emerging Markets Fund.
Stock example: Air Arabia
Air Arabia is a low-cost airline operating out of Sharjah airport, which is to Dubai what Luton is to London. So although a rich Emirati or expat in Dubai may not choose to use the airline, it nevertheless fulfils an important niche in serving price-sensitive travellers in the region (as well as cost-conscious Jupiter fund managers).
Despite being a budget carrier, Air Arabia planes are typically clean and on time, plus they fly to hundreds of destinations. It’s essentially replicating the EasyJet or Ryanair model, and appears to be doing so very well. The company is also on a stable financial footing, which certainly isn’t something you get from all airline stocks, as it owns its planes (rather than leasing them) and has a strong balance sheet. Despite these attractions, we believe its growth potential has been overlooked by the market and so we have identified it as a source of underappreciated change in the region.
Situated on-site at Sharjah airport, Air Arabia’s modest headquarters are emblematic of the company’s focus on low costs and efficiency. (Photo: Ross Teverson)
Rapid and dramatic change in Saudi Arabia
Once I reached Saudi Arabia it became clear that reforms were real, far-reaching and occurring rapidly. To give a few examples: there has been a crackdown on corruption; the ultra-conservative elements in society have been side-lined; an entertainment sector is being allowed to develop; and there are important improvements to women’s rights (albeit from a very low base), with surging female participation in the workforce.
At a stock market level, the planned listing of the state oil company, Saudi Aramco, would make it one of the most valuable listed companies in the world. Furthermore, the inclusion of Saudi Arabia in the MSCI Emerging Markets Index, which is likely to happen in 2019, will put it more on the radar of global passive and active investors.
Saudi Arabia has a young population – half of its citizens are under 25 – and my impression was that most people seem to approve of what the crown prince, Mohammed Bin Salman is doing to diversify the country’s economy away from oil and make it more socially sustainable.
Source: The General Authority for Statistics (GAStat), mid-2016 population data, https://www.stats.gov.sa/en/5305
The China of the Middle East?
When I was in Dubai, the management of one company I met described Saudi Arabia as being as important for the Middle East as China is for Asia. That might sound like a bold claim, but there are certainly some interesting parallels with China. Saudi Arabia will host the G20 summit in 2020 and I spent some time in the King Abdullah Financial District, where it will take place. Today much of the area is a construction site, but I was strongly reminded of visits to Beijing or Shanghai where political will created the drive to complete projects rapidly.
Also, Saudi Arabia appears to be taking cues from the China’s fixed asset investment model, by investing in infrastructure projects to remove bottlenecks to economic growth. For example, a new Riyadh metro system and high speed rail link to the airport are currently under construction.
Another potential parallel with China is the notion that Mohammad bin Salman has used a corruption crackdown to reinforce his own position of authority, in similar way to how President Xi used anti-corruption measures in his first few years in office. So far, the crown prince’s crackdown has not led to any significant repercussions, but undoubtedly it has caused some resentment amongst high-profile members of the royal family and the business people impacted by it.
A view over Riyadh towards the new King Abdullah Financial District, where the G20 summit will take place in 2020. (Photo: Ross Teverson)
The importance of being selective
So while I certainly believe that change is necessary to set Saudi Arabia on a more economically sustainable path, it is likely there will be challenges along the way and investors will need to be selective to identify the best opportunities.
Passive money will blindly buy into the largest index constituents in 2019 if Saudi Arabia is included in the MSCI Emerging Markets Index, which it is currently timetabled to do. While it is possible that we may increase our exposure to Saudi Arabian equities in the Jupiter Global Emerging Markets Fund this year, if we do so we will only invest selectively into those companies where we can identify underappreciated positive change.
One interesting sector is health care, where we can identify a number of under-researched, well-run businesses that should benefit from significant structural change. Health care spending in Saudi Arabia is set to rise as medical insurance moves from the state to the private sector. Furthermore, the improved availability of high-end services domestically means that some patients who previously travelled overseas for treatment will spend more on health care at home. A high incidence of chronic conditions such as diabetes in Saudi Arabia and rising demand for long-term care for elderly patients also suggest structural growth in health care spending.
Source: Ministry of Health, Kingdom of Saudi Arabia, 2009 & 2018 (based on the conversion of Hijri calendar 1430H and 1437H)
In other areas, however, caution would be needed. For example, the Saudi Arabian banking sector looks attractive at first glance, but my view is that there may be hidden asset quality risks for some banks. If we do further research into Saudi banks we will pay particular attention to the quality of the banks’ loan books. Furthermore, some much-needed economic reforms, like the removal of fuel subsidies, the introduction of VAT and levies on expat workers could have a short-term negative effect on economic growth.
Saudi Arabia likely to be an area of increasing investor focus
As of today, foreign investor participation in the Saudi stock market is low, but with so much changing on the ground and a decision on the potential 2019 inclusion of Saudi Arabia in the MSCI Emerging Markets Index likely to come later this year, Saudi Arabia looks set to be an increasingly important story within the emerging markets asset class.
Key fund risks
The fund invests in emerging markets which carry increased volatility and liquidity risks. The fund invests in smaller companies, which can be less liquid than investments in larger companies and can have fewer resources than larger companies to cope with unexpected adverse events. As such price fluctuations may have a greater impact on the fund. This fund invests mainly in shares and it is likely to experience fluctuations in price which are larger than funds that invest only in bonds and/or cash. The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request.
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All figures correct as at 30.06.2019.