Saudi Arabia: A Rising Investment Destination

The Middle East and North Africa region, and in particular Saudi Arabia, are becoming a bigger and more relevant part of the emerging markets equity investment universe, offering both structural reform and cyclical tailwinds. Saudi Arabia appears committed to diversify its economy away from oil dependence and current economic, and social reforms are shifting Saudi Arabia from an exporter of capital to an investment destination sought after for its long-term growth potential and diverse economy.

The VanEck Emerging Markets Equity Investment Team’s recent trip to Saudi Arabia has us excited about the long-term investment prospects of Saudi Arabia and the emerging investment opportunity it presents, though we remain cautious on the punchy valuations the market currently offers. Our visit confirmed that Saudi Arabia’s “Vision 2030” program has moved from being just an ambitious hope to a guiding framework that is being implemented through different realization programs and focus sectors with emphasis on long-term investments.

Saudi Arabia – Macro-Economic Drivers

Unlike most of the world right now, we experienced a refreshing buzz on the ground in the Gulf Cooperation Council (GCC), given a favorable combination of structural reform, positive economic spillover from higher oil prices driving stronger government and private sector investments, and a relatively low inflationary environment with USD pegged currencies. It’s worth noting that the weight of GCC is now approaching 8% of the MSCI EM index, with Saudi Arabia representing more than half of that¹.

Saudi Arabia’s Growing Weight in the MSCI EM Index

Source: FactSet data for MSCI EM as of 09/30/2022. *2022 represents YTD data as of 09/30/2022.

Social Reforms and the Rise of New Economy Sectors

Social reform and loosening up of restrictions are the most visible change. Female empowerment through the increase of female participation in the workforce was one of the explicit goals of Vision 2030, with a target to reach over 30% female labor participation by 2030.² Today with all the positive reforms in the country, we have witnessed a very rapid rise of female employment, reaching over 33% of the workforce currently from less than 20% in 2018 and exceeding the 2030 goals significantly ahead of time.³ One key enabling reform that supported women’s mobility and access to workplaces is the lifting of the female driving ban in 2018, granting women in Saudi Arabia the right to drive. We welcomed seeing many women driving their cars around Riyadh during this visit and were particularly pleasantly surprised when we even encountered a female Uber driver.

We believe the social reforms have resulted in the rise of investment opportunities in the entertainment, tourism and leisure sectors. Historically, entertainment options in Saudi Arabia have been limited due to restrictions against movie theaters, music venues and concerts or even allowing social mixing of men and women at restaurants or cafes, with restaurants typically having separate sections for families and women away from male only sections. This meant that shopping for physical goods was the most common way to pass time.

Today, almost all such restrictions have been removed, with the notorious moral police nowhere to be seen anymore. This has opened up the opportunity for investors to take advantage of the “new” entertainment sector offerings, such as large outdoor seating areas and fine dining options, as well as music festivals that would have been unimaginable only a few years ago. The likes of Cipriani, L ’Entrecote Café de Paris, Nusr-et and other globally known fine dining establishments were quick to open up in Riyadh – the largest city in the GCC by population with around 8 million residents and solid purchasing power. There are now long waiting lists to get reservations at these restaurants. While many Saudi women choose to continue wearing the traditional head-cover and “abaya” (the black traditional over-garment) while going out and at their workplace, this is no longer a requirement, and we have seen women dressed in a variety of fashions around town.

Our visit also coincided with the first week of this year’s “Riyadh Season”, a large state-sponsored annual entertainment festival with a series of music concerts, live performances and pop-up restaurants and shops. As one walks around on the festival grounds and visits some of the restaurants, it feels very much like being in Dubai or any other entertainment hub minus the alcohol, which is a long way away from the not too distant past.

Senior Investment Analyst Ola El-Shawarby at the “Riyadh Season” 2022.

Saudi has one of the youngest populations globally, with around 70% of the population below the age of 34.⁴ Most Saudis are happy with the reforms that are creating a positive buzz among consumers and companies alike. What has been interesting so far this year is that despite consumer confidence being at an all-time high, many of the listed “traditional” consumer companies in the retail space have reported relatively disappointing results. It appears there is an increasing share of the consumer wallet now directed towards the newer entertainment options and even domestic tourism.

We are also seeing positive reforms related to mortgage subsidies to increase home ownership, education, healthcare and insurance, which are all opening up opportunities for banks, private schools, private hospital groups and private insurance companies.

Economic Reforms: Vision 2030, The Public Investment Fund (PIF) and The National Investment Strategy (NIS)

Vision 2030 (V2030) was launched in 2016 and at a very high level aims to diversify the Saudi economy away from oil.

Following the 2015 decline in oil prices, Saudi spent several years going through fiscal consolidation and expanding the government’s non-oil revenue base by introducing initiatives such as VAT for the first time (initially at 5% in 2018 and increased to 15% last year).⁵ With the recent rise of oil prices, the government continues to show fiscal discipline and this time around we have not seen the usual cash handouts given to Saudi nationals that we have seen in past boom oil cycles. As a result the 2022 budget is expected to show a sizable budget surplus projected at more than 7%.⁶ From our conversations with Saudi’s Minister of Investments, it was confirmed that this time around the role of the government as the main driver of growth through direct budget spending has changed with only ~10% of Saudi’s $1 trillion budget directed to CAPEX. The rest is focused on OPEX and defense, and the responsibility of boosting economic growth is being shifted to ex-budget state-owned entities and most importantly PIF, Saudi Arabia’s sovereign wealth fund.

The PIF was originally established in 1971 as a strategic investment vehicle under the oversight of the Ministry of Finance. However, it was effectively relaunched in its current form in 2015 to now become one of the largest sovereign wealth funds globally under the supervision of Saudi’s Council of Economic Development and Affairs, an entity spearheaded directly by Saudi crown prince (Mohamed Bin Salman).

The PIF plays a pivotal role in the execution of V2030 and KSA has announced giga projects like NEOM and The Red Sea. The fund has been empowered by the Saudi leadership to invest domestically and overseas with a private sector mindset driven by risk/reward and governance targets with an aim to invest at least SAR150 billion (~40 billion) in the local economy by 2025.⁷

Key sectors identified by PIF for investments to drive higher non-oil revenue growth include technology, financial services, EVs, renewables, food & agriculture, entertainment & leisure, healthcare, consumer, aerospace & defense, metals & mining and real estate. We have seen PIF building “national champions” in the different sectors like banking, renewables, technology and others to carry out the growth plans, and we have met with the management of several of those companies, including Saudi National Bank (financial services), ACWA Power (renewables and power generation) and Elm (technology and digital solutions).

Since the transformation of PIF in 2016, the fund has received many asset transfers from the government in the form of both cash and companies. Currently, PIF has just over $600 billion of assets and has a target to reach over $1 trillion in assets by 2025.⁸ From our conversations with leadership representatives of PIF and the Ministry of Investments during the trip, there is a clear shift in mindset and attitude to reposition Saudi from just an exporter of capital to a welcoming capital destination. Saudi’s National Investment Strategy (NIS) was published towards the end of 2021 to help carry out V2030 targets by tripling gross fixed capital formation by 2030 to reach 30% of GDP, while also increasing the share of FDIs from a mere 1.5% of GDP in 2021 to 3.4% by 2025 and further rising to 5.7% by 2030.⁹

According to PIF, the fund is looking to crowd in—not crowd out—investors by catalyzing and de-risking projects initially then opening them up for private sector investments. We have also seen PIF monetizing assets through a series of IPOs and secondary stake sales on the Saudi stock exchange over the past two years, allowing investors like ourselves the opportunity to “partner” with the fund.

We also heard about the intention of introducing several special economic zones in the near future that will offer more advantageous pro-business regulations and incentives. While we do not know any details yet, one trend that we have started seeing in the UAE, which has reflected positively on the stock market, is the gradual elimination of foreign ownership limits. If we start seeing similar moves in Saudi, perhaps starting with special economic zones, that would be very positive.

Tailwinds from Infrastructure Development

Large-scale Giga Projects

NEOM
As mentioned PIF is the backer of Saudi’s large scale projects with the largest and the most known one being NEOM, an ambitious project spanning ~26,500 square kilometers—almost the size of Belgium—by the Red Sea in the northwest of Saudi Arabia. We only visited the headquarters in Riyadh and not the project site given the distance away from Riyadh. While it was hard to get any specific details during our meeting on exact timeline and plan, the project is marketed as a very futuristic and sustainable city with some press articles quoting $500 billion as an estimated development budget.¹⁰ We await more details to be revealed over time, but one data point to keep in mind is that Saudi won the bid to host the 2029 Asian Winter Games at The Trojena Mountain Resort within NEOM¹¹. At least that gives some clarity on timeline for part of the project covering an area of nearly 60 square kilometers with elevations ranging from 1,500 meters to 2,600 meters.

Tourism and Entertainment Projects
Saudi has always been a consistent religious tourism destination as home to the two holy sites for the Islamic faith and has been developing the areas around Mekkah and Madinah to accommodate more visitors in the future. More interestingly though, we have seen domestic tourism numbers pick up significantly within the country due to the relaxation of restrictions. Saudis have started to travel within the country more to explore different beach or mountain areas or attend some of the festivals in Riyadh and Jeddah, which has been evident in car rental numbers for example.

Saudi is also developing 2 giga projects by the Red Sea coast named The Red Sea Project and Amaala— two luxurious tourist beach destinations to capitalize on the virgin untapped shores, dive sites and marine life in the Kingdom and aiming to attract tourists globally. During our visit, we also visited the sites of Qiddiya, another large project under development close to Riyadh, which is meant to be an entertainment city with Six Flags and others announcing plans to build parks there.

Cultural and Historical Projects
Our favorite visit of all was our tour of the Diriyah Gate project, guided by an enthusiastic young Saudi woman. Here, a new cultural city is being built in the traditional architectural style of the area and centered around a 300-year old historic mud-brick city – now classified as a UNESCO heritage site – that was the first ruling house of the Al Saud family (after which the Kingdom of Saudi Arabia was named). Aside from the historic site which is very interesting in and of itself, the project will include residential and commercial real estate, including luxury and mid-level hotels to attract both local and international visitors.

Tour of ‘Diriyah Gate’ conducted by a female tour guide.

Green Energy Transition and ESG Initiatives

Green energy transition and green initiatives have come up in many of our meetings. As part of V2030, Saudi wants 50% of its power generation coming from renewable energy, as Saudi also has an abundance of solar and wind resources.

The PIF was given the mandate to develop 70% of the country’s renewable energy pipeline, which they are doing through majority owned power generation, renewable energy and water desalination national champion ACWA Power, which was listed on the Saudi stock exchange in 2021 (Ticker: ACWA AB). We met with ACWA Power’s management, who will be developing, operating and partially owning the bulk of Saudi’s renewable energy projects. To put it into context, if we assume that Saudi’s capacity goes from ~80 GW today to ~120 GW by 2030, this would suggest an additional ~60 GW coming from renewables by 2030, from only 1 GW today. ACWA Power is expected to develop ~42 GW of those and presents an attractive investment opportunity. ACWA Power is also developing NEOM’s 4 GW green hydrogen project, which is supposedly going to be the world’s largest utility scale hydrogen facility.

It is also worth mentioning that the PIF invested in US-based listed EV producer Lucid and currently owns more than 60% of the company. The latter is currently in the process of building Saudi’s first EV production plant with a capacity of 150,000 vehicles.¹²

Saudi is clear that it is not abandoning hydrocarbons but will focus on increasing energy efficiency, reducing emissions and increasing carbon capture through investing in technology and emission tracking tools for the oil industry globally.

Saudi Arabia: Compelling Investment Opportunity

We believe the economic and social reforms in Saudi Arabia could present an interesting investment opportunity with the country’s transition to a more open society. The infrastructure development coupled with the positive steps towards opening up the economy to foreign investors is a positive development for the country.

The transformation we witnessed in Saudi has been really eye opening and exciting. The significant change in terms of pace and magnitude on the ground is impressive. We walked away from our visit to Riyadh feeling excited about the changes and positive on the outlook and investment case, and looking for better valuation entry points to capture the opportunities we see.