Saudi Banks Rally Before MSCI Rules on Emerging Markets Tag

Updated on
  • Index manager to announce classification decision on June 20
  • Riadh-based Al Rajhi Bank jumps amid analysts recommendation

Bank and insurance shares jumped in Saudi Arabia hours before the country learns whether it may begin the formal process to become classified as an emerging market by MSCI Inc., a development that might boost its stock market for months.

The banking sector of the Tadawul All Share index leaped 4 percent and closed at the highest level this year. MSCI, a global index provider, will announce on Tuesday afternoon New York time whether it will include Saudi Arabia in its emerging market watch list, which allows for its possible addition to the category in 2018.

That approval would increase demand for Saudi shares as fund managers who passively track MSCI benchmarks would have to buy or increase their holdings of newly included stocks.

While the benchmark Tadawul index has underperformed the average return for developing economies in 2017, strategists have said the reclassification is possible and would be positive for the country’s equities, given the kingdom has carried out changes to attract foreign investors as the government diversifies the economy away from oil.

“Local Saudi Arabian investors are not pricing” an addition to the watch list, according to EFG-Hermes strategists Mohamad Al Hajj and Simon Kitchen. “MSCI’s announcement could force these investors to re-engage, taking Tadawul towards the high end of its trading range of 16 times its one-year forward price-to-earnings” ratio.

An inclusion could lead to improved valuations, liquidity and foreign inflows to the country’s market, according to strategists at brokerage Arqaam Capital. Equity investors can expect returns of about 20 percent in each of the years leading up to the upgrade and including in the year of the event, according to EFG-Hermes’s research of other countries that gained emerging-market status. Then they can expect a decline of 12 percent in the following 12 months.

READ: Why Saudis’ MSCI Bid Matters And What They’ve Done to Get It
READ: Emerging Stocks Face New Era as MSCI Ponders $9 Trillion Markets

Lenders including Banque Saudi Fransi, The Saudi British Bank, Bank AlBilad and Arab National Bank each rose at least 4.4 percent on Monday. All 12 members of the Tadawul Banks Index gained in the session.

Shares in banks that have been able to keep funding costs at low levels without sacrificing deposit growth are seen as increasing from an eventual inclusion, provided valuations are attractive.

Below are stocks that may benefit from an eventual addition to the watch list:

  • Banks and insurers: Al Rajhi Bank, Samba Financial Group, Saudi British Bank and National Commercial Bank are seen as potential gainers by EFG-Hermes and Arqaam Capital. They’re seen as well-positioned to benefit from higher global interest rates, with strong franchises, and more resilient credit growth than some competitors.
    • Arqaam Capital sees Al Rajhi as “by far the best-positioned,” given its higher exposure to the retail market; its cost of funding last year increased by just 10 basis points compared with 30 basis points for the sector, while deposits contracted by just 50 basis points this year through March versus 90 basis points for the sector.
  • The Company for Cooperative Insurance (Tawuniya): The insurer is seen currently as undervalued by Arqaam Capital. “We are optimistic about the outlook for its motor and property-and-casualty segments despite the weaker performance last quarter,” analysts Michael Malkoun and Jaap Meijer wrote in a report last week. 
  • Bupa Arabia for Cooperative Insurance Co: The stock is seen as a long-term investment by EFG-Hermes, “based on scarcity rather than index inclusion.” Al Hajj estimates there will be room for $150 million from foreigners keen to buy the shares but it will be difficult for them to find locals willing to sell. A similar case was seen with Aramex PJSC and Emirates NBD PJSC in the United Arab Emirates, when the country was added to the emerging market in 2013.
  • Saudi Telecom Co: the telecommunications provider is seen as a “relatively high yield play” by EFG-Hermes, which includes it among its top 20 picks for the Middle East. Arqaam has a hold recommendation, as its valuation remains in line with the sector, and its dividend yield is considered secure until end of 2018.
  • Fawaz Abdulaziz Al Hokair: Arqaam sees store yields picking up this year and in 2018, as the retailer introduces new and more profitable brands and “cleans up” its current store network.
  • Jarir Marketing Co: seen as the main beneficiary of the restoration of bonuses and benefits in the kingdom, as well as the closure of unorganized mobile shops, Meijer and Malkoun wrote.

READ: MSCI Bounce for Saudi Shares May Happen Sooner Than You Think

    Quotes from this Article
    Before it's here, it's on the Bloomberg Terminal.