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For Professional Investors and Advisers Only

April 2018

Saudi Arabia – An Emerging Opportunity

RWC Emerging & Frontier MarketsStrategy Update Q1

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The Team

John Malloy and James Johnstone co-manage the RWC emerging and frontier markets strategies. Al Qureiyeh is the analyst responsible for the MENA region and covers the healthcare and healthcare providers sectors. The team is composed of a further 15 analysts, economists and strategists based in Miami and Singapore, many of whom have worked together for over twenty years. The team joined RWC Partners in 2015 and now manages c. $5.5bn for its clients.

Emerging and frontier markets represent the fastest growing countries in the world. The RWC team believes the continued growth in these markets represents opportunities across a range of industries.

The highly experienced and dedicated team takes an index-agnostic, opportunistic approach which allows it to explore investment opportunities that are often off the beaten track.

The team provides an overview of the first quarter of 2018 before exploring investment opportunities within Saudi Arabia.

RWC Partners Limited Verde, 10 Bressenden Place, London, SW1E 5DH | T +44 (0)20 7227 6000 | F +44 (0)20 7227 6003

RWC Emerging & Frontier Markets 3

RWC Emerging & Frontier Markets

Review of Q1 2018

Emerging Market Equities and Frontier Market Equities appreciated during the quarter. A combination of protectionist rhetoric and fears concerning US Interest Rate hikes led to a spike in volatility and a global sell-off in equities. Emerging and Frontier Markets outperformed Developed Markets during the quarter and the environment continues to be conducive for the asset class. The MSCI Emerging Markets Index appreciated 1.3%, the MSCI Frontier Markets rose 5.0% and Developed Markets (MSCI AC World Net Total Return) fell 1.6%. The RWC Emerging Markets Fund was up 0.2% and the RWC Frontier Markets Equity Fund rallied 6.7%. Global growth remains robust, inflation and unemployment are contained and macroeconomic data is encouraging. Oil rose 5.1% during the quarter and we continue to see a promising blend of strong demand and declining inventory data amid muted US shale production. Copper gave back a small portion of its 2017 gains but we believe increased demand and constrained supply will support the price over the long term.

Brazilian oil company, Petrobras, was a significant contributor to the performance of the RWC Emerging Market Equity Fund. The share price rose 37.4% during the quarter, as the company reported good earnings results. The company reported BRL 44 billion of free cash flow for 2017 and showed declines in operating costs and net debt. Improving fundamentals combined with further asset sales and cost cutting should continue to support the share price and the company trades at a 10% discount to global peers on an EV/EBITDA basis. Vietnam and Saudi Arabia also performed well during the quarter. Steel company, Hoa Phat Group, rose 29.3% during the first quarter bolstered by strong earnings results. Revenue and net profit reached a record high of VND 46.8 trillion and VND 8 trillion respectively (+38% and +21% year-on-year). The outlook for the company remains strong

given its competitive advantages, the commencement of the new galvanized steel project of 0.4m tons/year in addition to the start of operations at the Dung Quat Integrated Steel rolling mill. Saudi Arabia’s Tadawul All Share Index rose 8.9% during the quarter as positive momentum built, culminating in index provider FTSE Russell including the country in its emerging markets index. The country’s largest bank by assets, National Commercial Bank, appreciated 21.5% in dollar terms.

Vietnam was a significant contributor to the RWC Frontier Markets Equity Fund, both relatively and absolutely. Ho Chi Minh Development Bank continues to perform well, rising 42.7% over the quarter, as investors take confidence from its targeted expansion within the retail and SME segments. Vietnam Prosperity Bank also rose markedly (+58.3%) and both companies should continue to benefit from a young and growing population, combined with the potential for increased penetration of consumer finance loans. Egypt was also a contributor to performance. Sentiment remains positive as the country’s macroeconomic environment becomes increasingly favourable for equity investors. Foreign exchange reserves are increasing, inflation is moderating and the central bank has reduced its policy rate from 18.75% to 16.75%. Property developer, Palm Hills, rose 30.8% during the quarter due to the prospect of higher margins from price increases. In Kazakhstan, Halyk Savings Banks rose 39.7% as it benefits from the country’s encouraging macroeconomic conditions of stable to higher commodity prices. Kenya also rebounded with banks, Equity and KCB, rallying 38.9% and 13.8% respectively. The country boasts greater political stability after the elections in 2017 and we believe the proposed modifications to the rate cap law will likely boost net interest margins.

RWC does not offer investment advice nor this should this be construed as a recommendation to purchase or sell any security. Past performance is not a guide to the future. The price of investments and the income from them may fall as well as rise and investors may not get back the full amount invested.


Saudi Arabia: An Emerging Opportunity

Introduction

His numerous reforms are spread across the private and public sectors in an attempt to utilise the Kingdom’s burgeoning workforce to develop a thriving, diversified economy. Significant catalysts such as the recent inclusion of the country in the FTSE Russell Emerging Markets Index, potential MSCI reclassification later this year, stable oil prices and an expansionary fiscal budget suggest a positive outlook for equities in the near to medium term.

Saudi Arabia is one of the world’s largest exporters of oil and the fortunes of the economy have historically been dependent on the commodity. An oil price boom from 2003 to 2014 fuelled a doubling of the country’s GDP, a 75% increase in household income and an increase from $18 billion to $720 billion in foreign exchange reserves. In the face of a changing global energy market, the Kingdom is currently undergoing a significant transformation led by Crown Prince Mohammed Bin Salman.

Vision 2030

The document released by the Saudi Government is a high level statement of its transformational plans for the Kingdom. Whilst Vision 2030 contains numerous pillars, goals and statistical promises, the key message is simple: progress from a government-driven economy to one that is privately oriented. This will require substantial financial support as the private sector only contributes roughly 40% of GDP compared to a global average of 60%. The Government plans to

double GDP, increase government revenue and create jobs for both men and women. The primary vehicle that will be used to support this transformation is the Public Investment Fund (PIF). The privatisation of the State Oil Company, Saudi Aramco, and the other 146 state-owned-enterprises1 over the course of the next decade will hopefully boost PIF assets to roughly $2 trillion from $230 billion today, making it the largest Sovereign Wealth Fund in the world.

FIGURE 1: Crown Prince Mohammed Bin Salman is the driving force behind Vision 2030

Source: Vision 2030, CNN

1 MEED Report – 27th March 2016 ‘Saudi Arabia has identified about 146 state-owned enterprises that could be privatised…’

RWC does not offer investment advice nor this should this be construed as a recommendation to purchase or sell any security.



FIGURE 2: By 2030 the Government plans to double GDP...

FIGURE 4: …create jobs for men and women

FIGURE 3: ...increase Government revenue

FIGURE 5: …and build the largest SWF globally

Oil Sector

Real GDP by Sector 2003-2030

2003 2013

400

$bill

ion

800

2030

1,600

Public Sector Private Sector

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

152

304

1,344

80176

128

37684164

Foreign Workers

2003 2013

Employment of Saudi Nationals 2003-2030

3.0

Pop

ulat

ion

(mn)

4.6

2030

10.8

Saudi Women Saudi Men

0

2

4

6

8

10

12

14

16

2.5

4.2

7.5

3.6

3.9

0.8

6.20.4

3.2

Non-Oil

2003 2013

Government Revenue by Source 2003-2030

79

$bi

llion

308

2030

460

Oil

0

50

100

150

200

250

300

350

400

450

500

138

322277

62

17 31$

billi

on

Norway

China

998900

828

Sovereign Wealth Funds

524494 457 441

359320 295

210

1,637

UAEAbu D.

Kuwait

SaudiSAMA

ChinaHK

Singapore

ChinaSAFE

Qatar

China N.Sec

UAEDubai

SaudiPIF

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

Assets PIF 2030 estimate

230

Source: Mckinsey, RWC, Bloomberg 2003-2030E



Source: SWF Institute, Morgan Stanley, RWC, Bloomberg 2018-2030E



The Economy

Saudi’s growth dynamics are poised for change in 2018 due to the Government’s announcement of an expansionary budget of almost SAR 800 billion ($215bn); a year-on-year increase of 5%. Consequently, the IMF has upgraded its 2018 and 2019 GDP growth forecasts to 1.6% and 2.2% from under 1% previously. Despite the Kingdom’s long-

term goal to diversify away from oil, the share of oil in GDP, exports and budget revenues is still high at 43%, 74% and 63% respectively. Growth in oil production driven by refinery expansions should support growth in the near to medium term. Public Debt to GDP is low at 17% of GDP, compared to an average of 47% in emerging markets.

Real Non-Oil Growth Real GDP Growth

2015

Saudi Real GDP Growth (%)

2016 2017 2019E2018E-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Oil Production Real-Oil GDP

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E-15%

-10%

-5%

0%

5%

10%

15%

20%Oil Production vs. Oil GDP

Source: RWC, IMF, EFG Hermes, Bloomberg 2015-2019E Source: RWC, Jadwa Investment, Bloomberg 2008-2018E

FIGURE 6: GDP Growth is set to rebound…

FIGURE 7: …aided by rising oil production




The Population

Saudi Arabia boasts a young and growing population with great potential. 32 million people are residents in the Kingdom making it by far the largest of the six GCC Gulf Arab States. 44% of the population is under 24 and by 2030 this demographic bulge could bring 5 million working-age Saudis to the labour market. Like other countries in the region, Saudi has a large expatriate workforce. Recent reforms such as the introduction of VAT, increases in

energy prices and expat levies could hurt consumption in the near term as expats depart. However, long-term fiscal sustainability is essential in order to diversify government revenue away from the dividends of state-owned enterprises and boost private sector job creation. The low participation of women in the labour force (19%) shows considerable potential if there is sustainable private sector job creation.

0-14y 15-24y 25-54y

Saudi Population (% of total)

55-64y 65y+0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Russia US OECD Korea

Labour Force Participation (%)

Mexico SouthAfrica

Turkey SaudiArabia

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Total Women Men

Source: RWC, Haver, Bloomberg, Indexmundi Source: RWC, Haver, Bloomberg, Morgan Stanley

FIGURE 8: Saudi’s population is young and growing

FIGURE 9: Low participation shows potential



economy is dependent on oil, the performance of the Tadawul has been uncorrelated to the oil price from 2012 to 2017. The market has lagged the MSCI Emerging Markets Index since January 2016 by 34% and we expect this trend to reverse over the course of the next 12 months. It trades at 12.7x 2019 earnings, slightly above the MSCI Emerging Markets Index but below the historical average premium of 13% above the index (2008-2017).

Qatar Turkey UAE Chile Mexico RussiaMalaysia Indonesia SouthAfrica

TaiwanSaudiArabia

$bi

llion

0

200

400

600

800

1,000

1,200

1,400

2012 2013 2014

Cor

rela

tion

2015 2016 2017-0.2

-0.0

0.2

0.4

0.6

0.8

1.0TASI Correlation with Oil Price

Qatar TurkeyUAE Chile Mexico RussiaMalaysia Indonesia

Average Daily Volume

SouthAfrica

TaiwanSaudiArabia

$m

illio

n

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

12,000

11,000

10,000

9,000

8,000

7,000

6,000

5,000

4,0002013 2014 2015 2016 2017

1,200

1,300

1,400

1,100

1,000

900

800

700

600

500

400

Tadawul vs. MSCI EM

Source: RWC, Bloomberg as at 16/03/18

Source: RWC, Bloomberg, Morgan Stanley 31/12/17



The Equity Market

The Saudi equity market is currently $475 billion and trades roughly $1 billion per day on the Tadawul, the only stock exchange in Saudi Arabia. It is also broadly diversified across many sectors. There are currently 178 companies listed on the stock exchange and Saudi officials aim to increase the number of listings to 250 over the coming years. Foreign institutional investors own only 1.5% of the market and have historically accounted for only +/-1% of total trading volumes. While the

FIGURE 10: Large Market Capitalisation

FIGURE 12: Low correlation to oil prices

FIGURE 11: Good Liquidity

FIGURE 13: Lags the MSCI EM Index


Market Capitalisation



Markets Index. Foreign institutional ownership is now 1.5% which is a fraction of regional peers (21% in UAE and 9% in Qatar) and the country represents only 0.05% of global equity portfolios. As MSCI recently noted, ‘major enhancements to the Saudi Arabian equity market’ have taken place over the previous year such as the implementation of the T+2 settlement cycle, the introduction of stock lending / short selling and the liberalisation of the QFI (Qualified Foreign Investor) programme rules.

Saudi Arabian Investment Opportunities

Vision 2030 highlights numerous sectors that have significant investment potential. Petrochemicals, Retail & Trade, Tourism, Healthcare, Finance, Mining & Metals and Construction should all benefit from Crown

Prince Mohammed Bin Salman’s reforms. The RWC team has considerable experience investing in the country and we outline some of our holdings below:

Source: Arabian Business

FTSE / MSCI Emerging Markets Index Inclusion

Index provider, FTSE Russell, announced the reclassification of Saudi Arabia to Emerging Markets status at the end of March and MSCI will likely follow suit in June. Estimates suggest that this will lead to around $13.0 billion in passive flows (ex. Aramco) but active flows could be considerably greater over the long term, as the capital markets will continue to be more attractive to foreign investors. The country will be 2.7% of the FTSE Emerging Market All Cap index and will likely constitute 2.4% of the MSCI Emerging

FIGURE 14: The Tadawul Stock Exchange



Banking and Insurance

Saudi Arabia has a consolidated and well-capitalised banking sector which benefits from a high share of non-interest bearing liabilities. Sector loan penetration is below regional peers at 56% of GDP. Loan growth has been subdued but is set to rebound in 2018/2019 due to improving macroeconomic conditions. The Real Estate market presents an exciting opportunity

FIGURE 15: Loan growth is set to rebound

FIGURE 17: Motor penetration set to increase

as residential mortgages account for only 7% of total sector lending and are just 5% of GDP. Furthermore the Government has targeted to increase household formation and ownership. The lifting of the driving ban on women will boost the insurance sector through a significant increase in the number of policies in the motor segment.

FIGURE 16: Mortgage market is underpenetrated

1993 1996 1999 2002 2005 2008 2011 2014 2017 2020E

Loan Growth (YoY%)

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2018 2019 2020

Motor Penetration Excluding Women

Motor Penetration Including Women

2021 2022 2023 2024 202520%

30%

40%

50%

60%

70%

80%

90%Motor Penetration Levels (2018 - 2025e)

Residential Mortgages as % of Total Lending

0%

2%

4%

6%

8%

10%

12%

14%

16%

Alawwal Alinma Albilad BSF SIBNCBSaudi

RiyadBank

Al Jazira Al Rahji SABB Samba ANBMortgageSector

Source: RWC, Bloomberg, Morgan Stanley 1993-2020E

Source: RWC, Bloomberg, HSBC 2018-2025E





National Commercial Bank

National Commercial Bank (NCB) is Saudi Arabia’s largest bank by assets and is the country’s dominant corporate lender. The SAR currency peg means that the Saudi Interbank Rate (SIBOR) is highly correlated to United States LIBOR which will benefit Net Interest Margins. The bank is best-placed to benefit from

higher market rates, as corporate lending is shorter duration than retail and priced at variable rates on the SIBOR curve. The stock is trading at 1.7x Price to Book (2019) and we still see c.20% potential upside in the next 9 months.

Religious Tourism

As highlighted in Vision 2030, Mecca and Medina draw millions of religious tourists from around the world every year, particularly during the five-day Hajj. Vision 2030 outlines the Kingdom’s goal to attract 15 million tourists a year by 2020 and 30 million tourists by

2030. This will be accomplished by improving the quality of services offered to Umrah visitors. The onerous visa process which strictly limited the number of non-GCC nationals allowed to visit the country has now been removed paving the way for future growth.

FIGURE 18: NCB has the largest asset base

FIGURE 20: Religious tourists set to more than double by 2030

FIGURE 19: NIMs will benefit from higher rates

NCB 19%

Al Rahji 16%

Samba 10%

Riyad 10%

BSf 9%

SABB 8%

ANB 8%

Alinma 5%

Alawwal 5%SIB 4%Al Jazira 4%

Albilad 2%

Asset Base Market Share (%)

2013 2014 2015 2016 2017E 2018E 2019E 2020E 2030E

Umrah Visitors

Peo

ple

(mill

ions

)

0

5

10

15

20

25

30

35

2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%NCB Net Interest Margin

Source: National Commercial Bank, RWC, Bloomberg 31/12/17

Source: Vision 2030, RWC, Bloomberg, HSBC 2013-2030E

Source: National Commercial Bank, RWC, Bloomberg 31/12/17


Al Tayyar

Al Tayyar is the largest domestic travel agency in Saudi Arabia. The company has 29% market share in the Saudi Air Travel market; four times that of the second player. We believe the company will be a large beneficiary of the country’s demographic trends in addition to religious tourism. Al Tayyar’s increased investment in the online travel space through leading

local mobile applications, Tajawal and Mosafer will likely drive online revenue to SAR 3.7bn ($986mn) by 2020 according to our estimates. The company also owns and operates hotels in Mecca to take advantage of the growth in Umrah visitors. It trades on 6.2x Price to Earnings (2019) and we see significant upside to the stock.

2015 2016 2017 2018E 2019E 2020E

Net Booking ($ million) LHS

Al Tayyar

Market Share of Overall Travel Market in MENA RHSMarket Share of Online Travel Market in MENA RHS

0

200

400

600

800

1,000

1,200

Net

Boo

king

($ m

illio

n)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Source: RWC, Bloomberg, HSBC 2015-2020E

FIGURE 21: Online market has considerable room to grow





Consumer and Retail

While short-term consumption numbers have been hurt by recent subsidy reforms and expat departures, we see the consumer and retail segment as a long-term beneficiary of the country’s austerity reversal. The Government’s implementation of direct benefit transfers will likely offset the impact of subsidy

reforms and Expatriates transfer 87% of their salaries outside of Saudi Arabia. Further integration of women in the economy amid private sector reform we believe will boost household disposable incomes which will lead to evolving consumption patterns favouring modern retail.

FIGURE 22: Government will support the Saudi consumer

FIGURE 23: Expats transfer 87% of salaries outside Saudi Arabia

Expat Saudi nationals

Remittances Local Consumption

0%

20%

40%

60%

80%

100%

120%

87%

13%

100%

Consumption in Saudi Arabia

Source: RWC, Bloomberg, Haver, HSBC 2018E Source: Euromonitor, OECD, RWC, HSBC 2017

MonthlyAllowance

50

32

20

-23

-9 -9

-22

CitizenAccount

VAT ExciseTax

Utility Fuel NetGains

-30

-20

-10

0

10

20

30

40

50

60Saudi Consumer Income 2018E

SA

R b

illio

n



Savola

Savola is one of the largest conglomerates in Saudi Arabia with operations focused on food production, retailing and investments within related sectors. The company is in the midst of a turnaround due to underperforming operations at its grocery retail business, Panda. Significant catalysts such as the closure of non-performing stores, inventory

FIGURE 24: Savola is attractively valued

reductions and the implementation of the loyalty program (1.2 million subscriptions) have been completed. The stock is attractively valued, as its $5.8bn market capitalisation is less than its stakes in its listed associates, implying no value for the group’s core operations. We see 34% upside to the current share price.

FIGURE 25: Panda set to recover

Savola Current

$ m

illio

n

Almarai Herfy Other RWC Est. Valueof Savola

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Market Capitalisation

2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E

Operating Margin LHS

Panda – Sales Growth and EBIT Margin

Sales Growth RHS

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

Source: RWC, Bloomberg, 28/02/17 Source: RWC, Bloomberg, 2010-2019E




Crown Prince is to succeed in transforming the Kingdom, the Saudi population will have to adapt accordingly. The shift is both structural and cultural; future prosperity will largely depend on the ability of the population to innovate, create jobs and improve their skills. The equity market is a function of this transformation and will likely offer up more investment opportunities as the country and population embrace economic and structural change.

Conclusion

The proposed reforms of Crown Prince Mohammed Bin Salman show that Saudi Arabia is on the cusp of significant change. Both John Malloy and James Johnstone recently visited the country and were encouraged by the level of positivity that Mohammed Bin Salman’s reform agenda has generated. Rice Hadley Gates have also emphasised their confidence surrounding the country’s reversal of austerity. However, if the

Saudi Arabia

Source: World Maps

Key Facts

Geography• 2.15 Square Kilometres• 83% Urbanisation• Capital City: Riyadh• Time Zone: GMT +3

People• Population: 32 million• Literacy: 87%• Religions: 85-90% Sunni Muslim,

10-15% Shia Muslim

History• Founded in 1932 by King Abdulaziz ibn Abdul

Rahman Al Saud (“Ibn Saud”)• Islamic Centre: “The Land of the Two Holy Mosques”

Macroeconomics• Nominal GDP: $750 billion (2018E)• GDP per Capita: $23,255• CPI average (% yoy): 3.5% (2018E)• USD/SAR: 3.75 peg• Policy Rate: 2.00 (2018E)


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Unless expressed otherwise, all opinions within this document are those of the RWC Emerging & Frontier Markets investment team.

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