Riyadh to Reality: On the Ground in the Gulf

In the latest episode of the Emerging Market Equities podcast, Nick Robinson speaks with Fraser Harle about his recent trip to the Middle East. They explore themes such as market optimism, diversification away from oil, governance and more.

Transcript

Nick: Hello, this is Nick Robinson from Aberdeen and you're listening to the Emerging Market Equity Podcast. Together with our expert guests we’ll dive into the driving forces behind emerging markets and uncover the opportunities that are shaping the future of this exciting region. So everyone's aware that the Middle East has dominated news recently. However, despite the continuing tensions and conflicts in the region, it's part of the emerging markets that has grown from almost nothing a decade ago to now be pretty similar in size to Latin America in terms of the benchmark weight. When you look at how most emerging market investment managers allocate capital to the region, most tend to have fairly few holdings, as historically some of the markets have been quite tricky to gain access to, and most managers at least don't have familiarity with companies there, or the same familiarity with companies as they might for more long standing benchmark countries. Also, there's quite a lot of new companies in the region as more local companies decide to pursue listings there. So it's an exciting under owned and under-researched part of the emerging market universe, which should be ripe hunting ground for bottom up stock pickers. So today I wanted to talk a bit more about the region and dive into some of the opportunities across the different countries and sectors. So joining me for this is my colleague Fraser Harle. Fraser is a Portfolio Manager and Analyst on the emerging markets team based in London. He helps run our fund that's aligned with the UN Sustainable Development Goals, as well as covering the utilities sector and he also covers some other highly regulated companies. So he's something of an expert on the region, and he's just returned from spending a month there in the Middle East, working out of our Abu Dhabi office. So, Fraser, welcome to the podcast. It's great to have you on. 

Fraser: Thanks for having me, Nick. Pleasure to be here. 

Nick: Brilliant. Well, how about if we kick off with, just tell us about the trip that you made to the Middle East. Where abouts you were and and what you did?

Fraser: Yeah. Thanks, Nick. Yeah, it was a really great trip. It was actually my third over sort of the last 18 months, where I went to Saudi and the UAE, one of which was actually with you. But it was great this time to have a bit of a longer trip where I could kind of soak up a bit more of the day to day experience and enthusiasm of of what it's like to be to be based in the UAE. So our first port of call really or my first port of call was the EFG Hermes conference in Dubai, which was about four days long. It's a massive conference, and I think the largest in the region. And this year the bank hosted 220 companies across across 12 countries. And, my colleague and I who were there, we were quite busy bees. We met with 46 companies over those four days with industries, you know, going across some car rentals to steel pipes all the way to hospitals, which hopefully goes a bit of a way to explain that, you know, regions a bit more than just oil and gas. And then after that, as you say, I was based in our office in Abu Dhabi, with our colleagues, Peter Dunbar and spent, you know, a bit of the time flitting between Dubai and Abu Dhabi, meeting companies that we haven't had the chance to meet with before. So, you know, it's great to be able to be on the ground there and also, you know, have the opportunity to see a few assets doing asset visits where I met with, Tabreed and Empower, a few district cooling companies, which was, which is great to see in person. After that actually I had a short hop across to Oman for a day of meetings, which was definitely quite a different feel to to the UAE. But still quite an exciting country to go and visit with, kind of quite a few, upcoming privatizations or, you know, public listings of Omani Investment authority, companies coming up. 

Nick: Yeah, that sounds like a brilliant trip. And of course, I remember our trip to Saudi in the UAE. I think that was last year, and that was good fun. So, yeah, I guess thinking about the different countries in the region. The main investable ones, at least are Saudi and the UAE with Kuwait, Qatar and Oman a bit smaller. I mean, when you think about the different countries, how do you think about them in terms of the opportunity set in each country and how the investment landscape differs across the region? And then, of course, you know, these countries all have quite different governance structures in the actual countries themselves than western democracies. So how does that influence how how you should think about investing in them. 

Nick: Yeah, that's a great question, Nick. And as you mentioned at the start, you know, we've seen quite a large increase in the way of the region in in our index, it's up about 60% versus five years ago. And you know you've seen the UAE kind of triple in its size of index weight and Saudi also grow by by more than a third. So I think you know, like you mentioned, each country has its own sorts of quirks. And I think, you know, the composition of, you know, what's actually on the exchanges is quite an important factor in terms of how we see what's interesting in one market versus the other. So in some of the smaller markets, like you mentioned, you know, Kuwait, Qatar and Oman, the indices are actually, you know, pretty heavily dominated by financials. I think Kuwait is maybe the, you know, the most extreme in that case where, you know, three banks make up an awful lot of the index. But that kind of, you know, constrains a bit about what we've been able to find within some of those markets, whereas, you know, maybe Qatar, you've got a bit more of the gas story with, you know, the increased in production from Qatar energies and then and then Oman, you know, the smaller market as well, I think because it's a frontier market, you've got even more perhaps constrained liquidity than you would in the others. But there's a bit more of an ambition to to graduate there. I think, you know, Saudi in the UAE, as you say, like a bit of a bit of a different kettle of fish, you know, the largest in the region. But there is still kind of like a bit of irrelevant difference between the two. I think Saudi, because it's got such a large population. You've seen some of the social reforms there. You've got a bit more of like a domestic consumption story that you can invest in there and maybe the emergence of some, you know, domestic manufacturing arms to serve the local industries, whereas UAE is a bit more sort of arms outstretched to the world. You know, 90% of the population are non Emirati and, and kind of outside of maybe the ADNOC complex in the UAE, most of the listed companies are geared towards sort of, you know, financials, and kind of population growth proxies there. So, I mean, I think like you maybe mentioned at the start, they're all a bit different, but I'd say as EM investors, they kind of follow a few good rules of thumb that we like to see, which are kind of, you know, young growing populations, broad infrastructure investment going on and kind of more broadly liberalizing or maybe more conducive business environments across the region, which is always, you know, what investors like to see. I think in terms of the governance question again, yeah, like you mentioned it, it's an interesting one. You know, these countries in the GCC, they're all effectively monarchies, right. And well, that certainly comes with a different approach than we have here in the UK. But there are benefits to that as well. I mean, I think what that really gives the economies and kind of how it opens up for opportunities set is kind of a longer term planning and and policy continuity that perhaps, you know, we see a bit more volatility and compared to the likes of other emerging markets and with the ambitions that are in these in the respective sorts of vision plans from each of the various countries in the GCC, these can kind of be given a bit of a kickstart or a helping hand from government directives, sovereign wealth funds like, you know, the PIF or or IDIA or Mubadala. And that kind of helps, you know. And the ambition, I guess longer term with the kind of governance structure that these countries are set up and how they aim to diversify their economies is to do a bit of future proofing for themselves from, you know, sort of swings we see in oil price and, and, you know, the energy transition, which continues to be ongoing.

Nick: Yeah. I mean, I'd like to kind of dive into that a little bit more in terms of you mentioned the, you know, the vision plan and the attempts to diversify economies away from oil. I mean, how do you think that's going? I mean, to my mind that's been, you know, one of these things that's been in the region that the governments have talked about for well over a decade now. And we do hear news flow about it, but it's not clear to my mind exactly how that's, that's going. 

Fraser: Yeah. I mean, there are different schools of thought. I mean, I'd certainly say that these are quite long term projects, right. But the progress to date and I think, you know, the ambitions there have been somewhat noticeable. There will obviously be hiccups along the way. But I think, it's important to maybe look at it at sort of the country level. So I mean, you know, if we compare sort of the last five years, if we're looking sort of 2019 to 24 where we've got the latest data, you know, the UAE has increased its share of non-oil GDP by 7.5%. Saudi has been even better than that, it’s increased it by 15%. And the forecasts that we see Nick with some of the some of the material that comes out the banks is that this non-oil side of the GDP should continue to grow at a much faster clip than sort of the oil GDP. You know, it is fair to say that while these economies continue to diversify, government budgets are still definitely very, very sensitive to oil prices in that kind of adjustment period as they go through that diversification, and that can kind of be seen by some of the differences or reliance as a of the various starting points in the required breakeven oil prices for government budgets. I think one of the main takeaways for me at the conference, was the confidence that lots of corporates talked about in terms of the change of mindset as part of the diversification away from oil. Lots of companies talked a bit about how, you know, historically, you saw when there was large oil price fluctuations that the government would maybe, you know, move away quite sharp and swiftly from government project announcements. You'd see sort of like a buildup of receivables from government entities on private enterprise and kind of further exacerbating sorts of the choke on the system from when oil price volatility was higher. And I think these days, you know, you're seeing governments being a bit more willing to appreciate it's about the destination, not the journey, to use that cliche, and kind of being more willing to take on a bit more debt or be a bit more flexible in supporting the economy during that periods.

Nick: Right. And I suppose one of the things, one of the big themes certainly in Saudi, that's somewhat linked to the diversification of the economy has been these social reforms. And, you know, in terms of kind of liberalizing. So women being allowed to drive cars, allowing people to go to theaters, cinemas, kind of coed classrooms. All that, all that stuff. I mean, how is that impacting the economy? And I suppose companies in particular, this kind of emerging kind of new, new consumption class that's being created? 

Fraser: Yeah. I mean, I guess for a start, it sort of opened up, you know, what should be half of the economy is a more direct consumer base than it was previously. So that's always good, you know, for investors to see, you know, I guess moving from sort of like pre reforms, I think employment of women in the country was let's call it like 18% in 2016. We've seen that increase, you know, all the way up to 36% on the on the latest data. So it's been quite a material shift in the employee base of companies. And also, you know, just the take home pay of Saudi families, you know, I think dual income families are now sort of 32% of, of households, up from kind of a similar percentage of female employment in 2016. I think the opening up the kingdom to sort of various entertainment options and, you know, more liberal reforms. It's had, you know, some positive effects for some companies and maybe more negative ones for others. I think one that I found quite interesting was a recent meeting we had with the owners of the Domino's franchise in, in Saudi Arabia, and they talked about how historically, you know, you saw the sorts of options people to go out to eat and how they have entertainment. It's being quite restrictive. There weren't cinemas or it was less easy to go to cinemas. And that allowed sort of the change that were there in Saudi, to kind of price, you know, relatively freely, you know, margins were quite high. You know, there wasn't too many options for people to go in and do things. But, you know, more recently you've kind of seen this proliferation of brands in Saudi. I'm sure you remember Nick when we were there. You know, you seeing, you know, brands, the American brands that you've never seen outside of America hve having restaurants in Saudi. And what that's done to sort of these restaurant chains and how it's changed their earnings trajectory going forward is they've moved from kind of like price led growth to more volume led growth. And that's obviously as a result of the competition as well, had an impact on their margins. I think another interesting kind of angle with the social reforms you're seeing is the greater growth of internal tourism and an internal Saudi demand for leisure spend. I guess we hear a lot about more in the press, the country wanting to drive inbound tourism. But, you know, we hear quite a lot, you know, speaking to car rental companies, there's a recent IPO, which is in a very large budget airline, which has a lot of regional and internal flights there. So I think there's quite a lot of opportunity there to and maybe finally, you know, with, with more women, in the workplace and more families with both mother and father working. You know, we've seen kind of a bit of a resurgence in the interest in private school education or education of nurseries and things like that. And I think there's some interesting opportunities that arise in that sector as well from kind of these social and demographic changes that we're seeing in Saudi. 

Nick: Yeah, it certainly feels like a huge number of opportunities there that that have opened up in in recent years. Moving on to the UAE. I mean, I suppose I have to declare a bit of a vested interest in this one and that, you know, when we look at our positioning in funds. Yeah, we're quite overweight UAE as we're seeing quite a lot of opportunities there. But certainly, you know, the market seems very exciting in terms of the amount of immigration that's coming in, business formation that's going on. Like you say, it's arms are pretty open to the world at the moment. Yeah, what was your experience, say, when you were looking at companies in terms of some of the new opportunities for the that are arising in that market?

Fraser: Yeah, no, I mean, I think there's always going to be the opportunity there. And I think we've seen it in more recent news as well of the real estate cycle. And I think that, you know, now extending a wee bit more from maybe the center of Dubai out to Abu Dhabi. Now you're seeing sort of increase in property prices as well. And, and I think, you know, maybe if you're willing to be a bit more adventurous all the way up to the northern Emirates in places like Ras Al Khaimah. And I think there's a bit more, you know, durability to that now than it was in the past. And maybe few more opportunities to think about different types of businesses, links to property that have kind of come to public markets. And I'm one of those I maybe mentioned at the start was was a district cooling company called Empower. And I think the first time I came across them was, one of our first visits to the Middle East. Nick. And and it's it's really quite a neat solution. So if you kind of think about the problem that the UAE has, about sort of 70%, if you can believe all of their electricity is diverted to cooling. And so what these what these district cooling companies aim to do is they kind of have a big aggregate or big massive air conditioner that's located sort of close to it in a around of a kind of a broad group of skyscrapers or big houses or villas. And that itself is the one machine that does the cooling and then pipe sort of cooled water down through a closed system, which is then converted to cool air on the other side. And that that has the effect of, of cutting energy costs by 35% versus when you're using traditional air conditioning or and actually on an emissions basis, reducing it by 50%. So it's kind of you're seeing kind of more opportunities arise in the region that, you know, economic, but also have a bit of a, a nexus of, of sustainability there as well. I think, also in the UAE with the kind of the large population growth that we were mentioning, we've seen some interesting companies come to the market. I think people don't necessarily yet think about the UAE as much of a tech hub as it really is. But, you know, we saw the IPO kind of, I guess the Deliveroo or the UberEats of many of the Gulf countries. You know, I think it operates in the UAE, Oman, Kuwait and, you know, I think that was quite an exciting opportunity to kind of see what what we will soon hopefully have a lot more of these tech companies come on to public markets and good populations for population growth there. I think there's also, you know, in terms of more opportunities like the immigration side of things that you talk about, there's always sort of the kind of infrastructure investments stories, that you see in the UAE. So like toll road companies, you know, again, I'll declare my interest now, the utilities, that you see a bit more of but yeah, I think, the market's grown an awful lot, as maybe I mentioned at the start, you know, you seen a tripling of of its relevant size in the emerging market index. And a part of that had just been more companies coming to public markets. And I still think it's quite early days for the kind of the depth of the breadth of the market there, which is still in the UAE, a bit more sort of old economy based. It's not got as much of the new and shiny, tech things and a lot of companies as it comes to market or the majority today have been more state directed as opposed to necessarily pure private enterprises. And so I think we should hopefully begin to see more of a second wave of these public enterprises coming, sooner rather than later.

Nick: Right. Yes,  I recall that from our trip, we met with a couple of companies that have essentially been spun out the government. So probably not ideal investments in terms of companies that have been, I guess, used to competing in an environment where they're not protected by the government. With that said, I think Empower was quite interesting, and I recall that in Dubai, going for a jog one morning and coming across one of their facilities and thinking, you know, this is a 6 or 7 storey high air conditioning unit, essentially. What about the smaller countries? So you kind of touched on Kuwait, Qatar, Oman earlier have you been able to find anything interesting in those countries which we might, might be able to invest in one day.

Fraser: Yeah, I have I mean, I think to me of those three that you mentioned, Nick, I think Qatar's I find it the most exciting. And I had I had the opportunity to meet with a few Qatari corporates at the EFG conference. They're both both engaged in, the gas industry. So you have both quite mouthfuls, Qatar Gas Transport Company and Qatar Navigation over there. Friends know them as Nakilat and Milaha and I guess the the interesting part or the area I find a bit interesting is just the amount of growth which is going to come from LNG out of Qatar. You know, up to the 2030s and then even a wee bit beyond as more of the North expansion continues. And I think LNG has no reasonable role as a transition fuel over that time period, especially in Asia. As the world kind of transitions a wee bit away from the from the coal side of things and more towards gas and eventually, you know, to storage and these companies operate make a lot more so, Nakilat operates a bit like a utility, heavily regulated company. It's a gas shipping company. So they, they own and operate very large LNG carriers. They contract with the state owned enterprise Qatar Energies, and basically move this gas that's produced domestically. And sometimes they have some contracts in America. They have one in, a few in Australia as well, you know, around the world to the consumption centers. And I think, you know, for us, the reason why I think it's an interesting opportunity is, as you kind of see a bit more about being able to invest along the growth of volumes by moving it around, rather than having to worry so much about the price of the commodity which is which is being moved around, which is something that’soften quite hard to find in emerging markets. And then, secondly, Milaha, which, you know, by coincidence, owns 36% of Nakilat. So it's a bit of a sister company. It focuses a little bit more on the onshore, the sorts of repairs, you know, the servicing of these industries. So it operates much smaller vessels than Nakilat would do. And I think I met with them when I was at the conference, as you mentioned, in Dubai. And they talked about the increase in production of gas that Qatar is looking at. You're going to need something like a 50-60% increase in the fleet of vessels that service that. And that represents, you know, quite an exciting opportunity in terms of servicing as well, and especially as, you know, with tight shipyards globally in Korea and China, you know, fleets are getting older and need more maintenance than they did historically. So I think, yeah, if you were to press me, those were sort of the the best opportunities I saw in the smaller companies.

Nick: I suppose one other thing about the region, it's quite different from the rest of the emerging markets in terms of how the governance of countries works. What about ESG issues within companies, you know, what are the issues that are typical to the region? And so you think companies, now that they're a bit more widely owned by managers, are beginning to take on board some of the kind of ESG messages that, managers tend to tend to communicate? 

Fraser: Yeah, definitely. It’s a really good and important question Nick. I think, you know, much like we see with other emerging markets is disclosure kind of like what we see elsewhere. So, while you might see companies that actually have, you know, really robust and strong controls to manage sort of their operational risks given the predominant investor base is domestic investors and they can, you know, meet with the companies more frequently or go and visit the sites more frequently. They don't often request the same sort of disclosures that, you know, foreign investors would that that helped them build comfort, given they can't be as close to the companies on a day to day basis as they can be. So, I guess, you know, just disclosures more broadly of sort of coverage of whether a company follows ISS controls, relative board committees on the governance side of things. And then I think one thing across the region that that we continue as investors to push for is, is the setting of targets, whether that be, you know, sort of a safety target, you know, a level of diversity among the workforce target, you know, emissions target or NOx targets. These are things that I think companies are more than willing to perhaps disclose on a snapshot basis, but maybe on a forward looking, element in terms of maybe constraining or reducing the impact of some of these risks, we haven't seen as much commitment as perhaps, we have seen in other regions. But certainly there are areas which are positive too, as well. You know, I think, Tadawul, which is the Saudi Exchange's, you know, continues to hold generally spoken to about it before, have workshops about in terms of disclosures and improving ESG links there and companies are also required to produce an outward facing to investors corporate governance report, which kind of gives a rundown of the year and a bit more about who's overseeing what, at the various companies. So I think, you know, there's still a bit to go. But yet companies are certainly willing and open to engage on topics and even if not necessarily disclosing the information, during meetings will be able to sort of share anecdotally and share figures about safety incidences and mixers on boards of directors and things like that.

Nick: Okay. So that's, encouraging some, some steps in the right direction at least. 

Fraser: Definitely. 

Nick: Okay. Well, I think that's probably a good place to to draw this to a close. So you know, thanks very much Fraser I really appreciate it. It's been it's been great. 

Fraser: Thanks for having me. It was good fun. 

Nick: Thanks to everybody today who took the time to listen in. If you enjoyed it, then please download our other podcasts from a website or wherever you normally get your podcasts. Watch out for the next episode and tune in.