Saudi opens the door to billions of inflows

Opening up access to foreign investors puts MENA on the map

Announcement that the Saudi cabinet has approved plans to open up its stock market to foreign financial institutions in H1 2015 is a long-awaited step towards MSCI EM index inclusion. Coming just over a month after the UAE and Qatar’s upgrade to EM status, the latest decision could eventually lead to the MENA region becoming as large as 5.2% (with Saudi accounting for 4%) of the benchmark compared with just 1.2% at present. MSCI could start evaluating the current proposals in June 2015, conclude the process by June 2016 and implement EM inclusion by June 2017.

MSCI EM inclusion could mean $13.3b-26.6b of net inflows

MSCI currently recognises Saudi via a domestic index with 45 constituents and $183b of free float market cap (43 stocks can currently be traded by foreign investors via swaps). With all but one stock having both a free float market cap above $1b and trading more than $1m per day, there is ample scope for this index to qualify for EM status (N.B.: it would be unprecedented to move directly to EM from standalone status). We estimate that depending on the number of stocks qualifying for EM inclusion, potential passive and active inflows could total anywhere between $13.3b-26.6b. The MSCI Saudi index constituents currently trade $1b/day.

Saudi’s macro fundamentals already in the big league

The opening of the Tadawul to foreign investors also confirms the authorities’ focus on economic diversification and steady economic reforms, particularly in the housing and labor markets, in our view. Macroeconomic fundamentals remain robust. Consumer and business confidence could be boosted by positive perceptions of the market opening. Increased foreign institutional investment is likely to help improve corporate governance, widen the pool of available savings and boost Fx reserves accumulation. The economy has weathered reasonably well the impact of the labour market reforms and we see growth hovering around 4%.

Overweight Saudi on macro drivers, positioning & valuations

We have maintained an Overweight stance in Saudi for many years and currently prefer this market to both the UAE and Qatar (where we are Neutral). Saudi’s market benefits from positive macro catalysts accelerating domestic oil production, improving Chinese activity data and slowing domestic inflation. Valuations are not looking stretched, trading at a consensus 2014 P/E of 14.6x with 14% earnings growth, in-line with its long-run average premium to EM.

Top Saudi picks: Samba, SABIC, SIIG and Yansab

Our fundamental analysts prefer stocks with exposure to earnings growth potential (Samba, SIIG) and attractive cash usage (SABIC, Yansab) and also believe investors will revisit the consumer and retail sector ahead of improving labour market trends.