Strategy Note /
Saudi Arabia

MSCI EM inclusion – SAR23.3bn inflow expected in 1st tranche

    SNB Capital
    28 May 2019
    Published by

    Saudi is set to become the eighth largest country by market cap in the benchmark MSCI Emerging All Cap index, with a weight of c2.90%. Saudi inclusion, with 31 constituents, will be carried out in two equal tranches, with 29 May 2019 being the effective date for the first tranche. The inclusion to the benchmark index is expected to result in inflows of cSAR46.2bn (cUS$12.2bn) from passive funds benchmarked to the MSCI Emerging All Cap index, of which the first step represents c50% (i.e. SAR23.1bn or US$6.1bn) of total passive inflows. TASI is now trading within the fair value range of 7,900 to 8,800 points, which we indicated in our 2019 Equity Strategy. We believe this has created valuation upsides in different sectors, which could result in flows from active investors as well, although on a selective basis.

    Saudi is all set to formally join the MSCI Emerging All Cap index, with inclusion occurring in two equal tranches. The first tranche coincides with May 2019 Semi-Annual Index Review (SAIR), to be effective on 29th May 2019. Thirty one Saudi stocks (see Exhibit 3) will be added at half of their Foreign Inclusion Factor (FIF) - adjusted market capitalization. The second and final tranche will be part of the August 2019 Quarterly Index Review (QIR), to be effective on 29th August 2019. The total weight of Saudi in the MSCI EM index is expected to be c2.90%.

    We expect the inclusion of Saudi in MSCI EM to result in passive inflows, at current prices, of up to cSAR46.2bn (or US$12.2bn), of which the first tranche is expected to see c50% of the total envisioned flows. However, we would highlight that cUS$1.48trn (c78%) of US$1.9trn benchmarked to MSCI EM index are active funds. With the Saudi market correcting by 10% from its peak of 9,362, it is currently trading within our fair value range of 7,900-8,800, and this could generate additional inflows from active fund managers. However, their buying would be selective in nature as they are not bound to invest based on MSCI EM weights.

    The merger of Saudi British Bank (SABB) and Alawwal Bank (Alawwal), with an effective date of 20 June 2019, will also have a positive impact on Saudi’s overall weight in the EM index. On a pro forma basis, it would increase Saudi’s weight by 7bps to 2.97% due to 1) the increase in the number of shares of SABB from 1.5mn to 2.05mn and 2) higher FIF from 0.2x to 0.3x. This is a function of Alawwal not previously being part of the MSCI Saudi index.

    In addition 39 stocks (see Exhibit 9) will be added to the MSCI Saudi Arabia Small Cap index. SIPCHEM and Sahara were previously part of the small cap index, however the merged entity, Sahara International Petrochemical Co, satisfies the size criteria to be migrated to the Mid Cap segment of the main MSCI Saudi index.

    Trading momentum has continued to keep Tadawul valuations elevated. Tadawul is trading at a 2019fPE of 14.7x, higher than the last 10 years average of 11.9x and a 41% premium to MSCI EM vs the last 5 years and 10 years average premia of 17% and 13% respectively. However, the recent market correction has brought back TASI to our fair trading range of 7,800-8,800 points and selective exposure can be sought in Banks, Cement, Retail and Healthcare sectors.