The first batch of Saudi ETFs in the A-share market—Huatai-PineBridge Southern Eastern Saudi Arabia ETF (520830) and Southern Fund Southern Eastern Saudi Arabia ETF (159329)—were listed this week. On July 16th and 17th, these two Saudi ETFs consecutively hit the upper limit, with a combined transaction volume of nearly 5 billion yuan on the first day.

In recent years, there has been a surge of interest in the Middle East market from various sectors in China, with Chinese companies such as Shein and Temu entering the Middle East market, and Chinese investors are also keen to understand the Middle East capital markets. In this Saudi ETF, the largest weighted stock is not the well-known oil giant Saudi Aramco, but the financial industry, which accounts for more than 40%. Other weighted sectors include raw materials (17%), energy (9%), utilities (9%), and communications (7%). Healthcare, consumer staples, discretionary consumption, technology, industry, and real estate also hold certain proportions.

It is worth mentioning that since the launch of "Vision 2030" a few years ago, Saudi Arabia has made significant progress in reducing its dependence on oil. In 2021, the country introduced a $3.3 trillion National Investment Strategy (NIS) plan. According to Goldman Sachs estimates, there is potential to attract about $1 trillion in total investment over the next decade. Because of this, the Saudi Development Fund (SDF), the Public Investment Fund (PIF, Saudi Arabia's sovereign wealth fund), and major Saudi banks will play a key role. Therefore, institutions believe that Saudi Arabia's banking industry, among others, will significantly benefit from this trend, as the continuous transformation of the capital market will play an important role in financing the $1 trillion project.

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"Capital Expenditure Supercycle" Drives the Saudi Stock Market

In fact, the popularity of Saudi ETFs is driven by investors seeing the opportunities brought about by the transformation of the Saudi economy. As early as September 2023, the international investment bank Goldman Sachs released a Gulf Cooperation Council (GCC) thematic report—Saudi Arabia Capex Super-Cycle: Diversifying, Decarbonizing, Digitalizing (Saudi Capital Expenditure Supercycle: Diversification, Decarbonization, Digitalization). This is to highlight the investment opportunities that will arise in the process of Saudi diversification transformation.

In 2021, Saudi Arabia launched the NIS, which is a measure taken to support the economic diversification of "Vision 2030," attract investors, and increase the country's non-oil exports. The goals include increasing the contribution of the private sector to GDP to 65%, increasing the contribution of foreign direct investment (FDI) to GDP to 5.7%, increasing the contribution of non-oil exports to GDP from 16% to 50%, reducing the unemployment rate to 7%, and positioning the country as one of the top ten economies in the Global Competitiveness Index by 2030. The NIS has formulated a comprehensive investment plan for various fields, including manufacturing, renewable energy, transportation and logistics, tourism, digital infrastructure, and healthcare.

This capital expenditure supercycle has also created major investment opportunities in the Saudi capital market. It is reported that the Saudi Stock Exchange (Tadawul), established in 2007, is the only stock exchange in Saudi Arabia, responsible for the trading of stocks, bonds, ETFs, and derivatives. Tadawul's total market value exceeds $2 trillion, with high market liquidity and huge daily transaction volumes, attracting a large number of domestic and foreign investors. The main industries include energy, finance, materials, industry, real estate, and telecommunications. The energy industry, especially Saudi Aramco, holds an important position in the market.

In recent years, the number of IPO activities in Saudi Arabia has increased significantly, especially in 2019 when Saudi Aramco's initial public offering (IPO) set the record for the world's largest IPO.

People close to PIF also told Yicai reporters that in order to strengthen the company's governance and information disclosure, PIF generally promotes the listing of invested companies. For example, ACWA Power, which PIF holds, is a typical case. The company went public a couple of years ago and is an international developer, investor, and operator headquartered in Saudi Arabia, focusing on power generation and seawater desalination projects. It is also one of the main customers of China's photovoltaic giant Longi Green Energy.

Saudi Banking Industry Financing Opportunities are GreatDespite Saudi Arabia being "rich in oil," the most significant sector in this ETF is banking. Wall Street institutions generally believe that financing for Vision 2030-related project expenditures presents a significant opportunity for the Saudi banking system, with planned project expenditures exceeding one trillion dollars, approximately 1.5 times the total loan amount of the Saudi banking system.

Industry insiders also believe that the uniqueness of the Saudi financial industry lies in the fact that under the Islamic financial system, they cannot charge or pay interest. Saudi financial institutions can obtain deposits at relatively low prices and provide loans at more competitive interest rates, especially to some high-quality companies. In addition, oil revenues provide ample capital for the Saudi financial system, and compared to American, European, or Chinese banks, Saudi banks have higher safety and capital adequacy ratios.

What is the outlook for the financing growth rate of the Saudi banking industry? To measure this opportunity, Goldman Sachs made the following assumptions previously — total project expenditures between 2023 and 2030 amount to one trillion dollars; the ratio of debt to equity financing is 60% to 40%, which means 600 billion dollars in debt financing; domestic banks' share in total debt financing is 50% (which means 300 billion dollars or about 10 trillion riyals in domestic bank financing), and the remaining 50% of the debt is financed through debt instruments and foreign banks. Under this assumption, Goldman Sachs estimates a compound annual growth rate of about 9% by 2030. Since 2021, loan growth in Saudi Arabia has exceeded 15%, which is about twice the growth in the GCC excluding Saudi Arabia.

What does this mean for the profitability of the banking industry? Goldman Sachs believes that the prospect of double-digit loan growth in the future can offset the compression of net interest margins. In the first two months of 2024, Saudi banks on average increased by about 8%, with an average price-to-book (P/B) ratio of 1.8 times (slightly above its historical median), but stock prices generally fell back after February, with a rebound trend since June. Institutions believe that the valuation is still reasonable, with an average return on equity (ROE) of about 14% (compared to a historical median of about 13%).

However, in this context, Goldman Sachs still prefers to invest selectively and has given buy ratings to Saudi National Bank (SNB), Riyadh Bank, Awwal Bank, and Banque Saudi Fransi.

Specifically, Saudi National Bank has one of the highest current deposit ratios covered by the investment bank, about 76% (as of the fourth quarter of 2023); strong liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) are about 258% and 110%, respectively, providing sufficient liquidity and funding buffers to maintain loan growth; the retail loan ratio is about 53%, which should help support net interest margins in a low-interest-rate environment. Institutions believe that the stock's 12-month forward price-to-book ratio of 1.8 times is attractive, as they expect a return on equity of about 16% in 2025.

In addition, Goldman Sachs has also given a buy rating to Riyadh Bank. The reason is that the bank's business orientation allows it to benefit from the implementation of Vision 2030-related projects; irrevocable credit commitments account for the highest proportion of loans, about 9%, providing a potential healthy loan growth channel for the coming years; strong liquidity coverage ratio and net stable funding ratio are 169% and 114%, respectively, providing ample liquidity and funding buffers to maintain loan growth. The stock's 12-month forward price-to-book ratio is 1.5 times, which is considered attractive, as institutions expect a return on equity of about 14.5% in 2025.

At the same time, Banque Saudi Fransi, which has been given a buy rating, also benefits from the 2030 Vision. The stock's 12-month forward price-to-book ratio is 1.2 times (the cheapest among Saudi banks), with a return on equity of about 12% in 2025.

Energy, digitalization, consumer goods, healthcare, and other sectors are also of interest to global investors and hold a certain weight in the ETF.Multiple domestic and international institutional investors have disclosed to reporters that as early as May 2024, the Saudi Capital Market Forum was held in Hong Kong, China, with the participation of 20 Saudi companies. Investors remain most concerned about the supercycle of capital expenditure in Saudi Arabia.

The aforementioned individuals informed the reporter that in terms of energy, investors have been focusing on Saudi Aramco's announcement to maintain its maximum sustainable crude oil production capacity (MSC) at 12 million barrels per day (rather than the previously planned 13 million barrels per day), and the potential impact this may have on Saudi drilling companies. Saudi Aramco continues to focus on strong capital discipline, shifting more investments from oil to natural gas and renewable energy, while also committing to maintaining a dividend policy composed of a basic and performance component. However, at present, Goldman Sachs has given Saudi Aramco a neutral rating.

Beyond upstream plans, energy transition remains at the forefront of discussions, with Saudi Arabia raising its target for renewable energy capacity from the previous 58.7GW to 130GW by 2030. Institutions believe that companies like ACWA Power, key players in renewable energy and green hydrogen investments, will benefit from the boost provided by national targets.

Regarding the chemical sector, since the beginning of the year, the average selling price of petrochemical products has improved, mainly due to supply tightness and improved market sentiment, with high oil prices further supporting prices. Goldman Sachs has a buy rating on Saudi Basic Industries Corporation (SABIC), one of the world's leading diversified chemical companies, primarily engaged in the production of petrochemicals, fertilizers, metals, and specialty chemicals. The company will benefit from several aspects — continuous improvement in its business model, a robust balance sheet that can support dividends and new organic growth projects, and energy prices remaining at relatively high levels.

Digitalization is another important area, with companies such as Elm and Jahez driving digital growth within their respective fields, in line with Saudi Arabia's digital transformation plan. Elm, wholly owned by PIF and established in 1988, is located in Riyadh and focuses on providing comprehensive digital solutions and technical services, covering areas such as e-government, digital security, information technology consulting, and project management; Jahez, established in 2016 and also located in Riyadh, is a leading online food delivery platform, offering services such as ordering, payment, and delivery tracking through its mobile app and website.

Furthermore, in the consumer sector, investors continue to focus on the prospects of population growth, interest rates, and inflation and their impact on consumption levels, showing greater interest in companies such as Americana, Extra, Savola, and Jahez.

In the healthcare sector, the growth in the number of patients and price increases are key areas of concern, and in the long term, institutions believe that the supply-demand gap remains a structural catalyst for the industry, along with opportunities from privatization, public-private partnerships, and inorganic growth.