RDR Capital 3Q16 portfolio update

This is our maiden post on the RDRcapital.com website. We plan to make regular quarterly updates on, initially, our Middle East and North Africa (MENA) portfolio and eventually on our global portfolio. In addition to the regular quarterly updates, we will publish market commentary on an ad hoc basis to discuss topics we view as relevant to our portfolios.

It is important to highlight that we do not actually invest in MENA markets. Rather, the purpose of the MENA portfolio is to demonstrate our investment philosophy and strategy, and to create a “virtual” track record. On the other hand, our global portfolio will have a verifiable track record; that is, it will reflect actual investments in the markets.

RDR Capital vs MENAinvestor.com

There is a difference in investment strategy between RDR Capital and MENAinvestor.com. MENAinvestor.com implemented a relative value strategy through the provision of fundamental research. That is, the portfolio was benchmarked to an index and the objective was to beat the index, which we have achieved consistently over the past year and 9 months. Therefore, the MENAinvestor.com portfolio was always (mostly) fully invested.

On the other hand, RDR Capital will implement a research-based value strategy with the objective of generating consistent positive absolute returns. The difference in strategy will be mainly visible through the levels of cash held in the portfolio. RDR capital can hold significant levels of cash if we have a view that markets are overvalued, or if we have not identified any compelling opportunities to invest in. Patience is key to the success of the RDR Capital strategy.

The RDR Capital MENA portfolio

The RDR Capital MENA portfolio will be incepted as of tomorrow, the 1st of October 2016 (markets in most of the MENA region are closed on Friday). As of today, we initiate positions in 15 shares representing compelling investment opportunities based on our fundamental analysis. The positions are not equal in size; the higher the percentage allocated to a position, the higher our conviction in the future expected returns from our investment. The reporting currency of the portfolio is the US dollar (USD), which does not make much of a difference at this stage as most of the Gulf Cooperation Council (GCC) currencies are pegged to the USD. Were we to initiate a position in Egypt (for example) in the future, then the currency will play a larger role in our investment decision making.

The MENA portfolio is composed as follows: 6% allocation (in each) in Almarai (Saudi) and Aramex (UAE); 5% in Emaar Properties (UAE), Samba (Saudi), NCB (Saudi), Doha Bank (Qatar) and Qatar Fuel (Qatar); 4% in Akaria (Saudi), Jarir Bookstores (Saudi), Agthia (UAE) and Herfy (Saudi); and 3% in Qatar Electricity and Water (Qatar), Middle East Healthcare (Saudi), Al Hokair Group (Saudi) and Saudi Hollandi Bank (Saudi). The balance is held in cash (35% of the portfolio).

There are a number of themes or trends that dominate our MENA portfolio, the most important of which is the emerging consumer. Supportive demographics and the continued expansion of the middle class in the MENA region is a key driver for growth in a number of sectors including consumer goods, food production and retail, real estate development and banking. As per above, we have initiated a position in Almarai, a very well managed leading food producer in Saudi Arabia, as well as in Agthia, another well managed food producer in the United Arab Emirates (UAE). We have also initiated positions in Jarrir Bookstores, Qatar Fuel and Herfy, all leading consumer facing businesses with solid balance sheets and strong potential for growth. Another key theme in the region is the growth of the healthcare sector. Unfortunately, healthcare shares tend to be fully valued and as such we struggle in exposing the portfolio to the growth in this sector beyond our relatively small investment in Middle East Healthcare (Saudi German Hospital) in Saudi Arabia.

Other trends in the MENA region include the growth of ecommerce, hence our investment in Aramex, a very well managed leading logistics company based in the UAE, and the growth in tourism. Our exposure to the tourism sector is through Emaar, the largest real estate, retail and leisure company in the UAE, and Al Hokair Group, a leading Saudi hotel and leisure operator.

We would have liked to have a larger exposure to the banking sector in the region as the sector looks compelling from a valuation standpoint. However, we limited our exposure to investments in Samba, NCB, Doha Bank and Saudi Hollandi Bank due to concerns about liquidity in regional markets, especially in Saudi Arabia, as well as our view that interest rates will remain “lower for longer”, impacting the banks’ profitability in the short and medium terms. Samba has the most liquid balance sheet in Saudi Arabia (loans/deposits ratio of 77% vs a sector average of 88%), which is an advantage in current low liquidity market conditions, allowing the bank to be well positioned for gaining high quality market share. NCB is the second largest bank in Saudi Arabia and the most profitable (2017e ROE of 17% vs a market average of 12.5%); it is well managed and has a fairly liquid balance sheet. Doha Bank is one of largest banks in Qatar, with a strong consumer franchise, and a very attractive valuation and dividend yield at current share price levels. Saudi Hollandi Bank’s shares trade at very attractive valuation levels as it has struggled with chatter in the market about ABN Amro selling its 40% stake in the bank to the Saudi Public Investment Fund (PIF). The bank has recently denied this “news”, and it is our view that this well run bank remains well positioned in the Saudi market.

Finally, we initiated a position in Qatar Electricity and Water, a regulated business which is set to benefit from the expected growth in the Qatari economy over the medium term. Qatar’s power generation capacity is expected to reach 13k MW by 2018, from c8.8 MW currently. This investment is also a dividend play (2017e dividend yield of c4% at current share price levels); Qatar Electricity is more profitable than its regional peers (2017e ROE of 20%) and its leverage is manageable (2016e net debt to EBITDA of 1.1x), which makes the dividend pay-out quite secure.

Overall, the MENA portfolio trades at 11.7x 2017e earnings, coupled with a 2017e ROE of 18%. The portfolio’s leverage is manageable with a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation, a proxy for cash earnings) of 1.3x and a solid dividend yield of 4.6% at current share price levels. The net debt to EBITDA measure excludes the banks, which trade at 0.8x 2017e P/TB (price to tangible book), coupled with a 2017e ROE of 13.7%, reflecting an attractive valuation.

Final thoughts

We remain cautious on global markets at these levels, with a number of risks ahead including reduced liquidity in bond markets, elevated levels of leverage in the Chinese economy and uncertainly in the political landscape with the US elections around the corner.

Our risk management process remains centred around the permanent loss of capital, which is avoided through rigorous fundamental analysis, in our view.