Unexpected Encounters in Saudi Arabia
By Tim Hanson
November 23, 2011
An Irish dairy farmer, an Indian yogurt production manager, an English baker, and a Sri Lankan banker. This isn’t the beginning of a bad joke, but rather a short list of characters Bill Mann and I met during our recent trip to Saudi Arabia. Suffice it to say, these were not the people I thought we’d be meeting.
And yet there they were, some in Riyadh, some in the middle of the desert, all drawn to the Wahhabist Kingdom of Saudi Arabia -- a country where women cannot drive alone and must be fully covered in public, where shops close five times each day for prayer, and where a square in the center of the capital city hosts beheadings every month -- because of its growing economy and promise of jobs.1 The economy is growing so strongly, creating so many jobs, and attracting so many foreigners to fill them, in fact, that the Saudi government has enacted Saudization quotas -- a requirement that bona fide Saudi nationals compose at least 26% of a company’s workforce.
Of course, we didn’t come to Saudi Arabia looking for jobs (we’re quite happy where we are, thank you), but strong economic growth attracted us just the same. That’s because growth is becoming harder and harder to find around the world, with Europe, the U.S., Japan, and China all seemingly stumbling. What’s more, because Saudi is a closed and difficult market to look at, there are not a whole lot of folks like us visiting the companies here.2 That’s an intriguing combination at worst; at best, it’s a fertile field for investment opportunities, so here we are.
At the newborn calf paddocks at Almarai's farm
And you too…
If you’re a shareholder of our funds, then you may already know that you have some direct exposure to Saudi Arabia via Almarai, a Riyadh-based consumer goods company that also happens to own the largest vertically integrated dairy farm in the world. That’s right, Almarai has custom-built massive modern farms to keep and raise Holsteins in the desert, and installed a base of infrastructure to milk tens of thousands of cows four times each day and then keep that milk cool as it’s transported to the processing facility. Alamarai’s brand is ubiquitous in coolers across the country, from hypermarkets to small corner stores, selling milk as well as related products such as cheese and yogurt. But Almarai is more than just dairy products. It’s also meeting Saudi Arabia’s rising demand for bread and other baked goods with its l’uisine line of products, and its recent acquisition of a chicken producer in northern Saudi Arabia has the company hoping that it will soon have Saudis eating fresh chicken instead of frozen birds imported from Brazil. Should Almarai continue to deftly allocate capital and grow its consumer goods business in the growing Saudi market, then this is the best kind of company we can own: one that we believe will compound our capital over the years at attractive rates of return.
Of course, Almarai isn’t the only company that has our attention in the region. Interestingly, however, none of the companies we are looking at have very much to do at all with the energy space -- the industry that’s driving the bulk of this region’s economic growth. That’s because, in these times of high oil prices, we’re not keen on paying premium prices to own part of what has historically been a volatile and capital intensive space. The point, though, is that there are always other ways to capitalize. Saudi Arabia’s economy should continue to grow as long as exporting oil remains profitable. We believe those profits will result in a rising standard of living and a growing population, two realities that we expect will spur additional growth across the consumer, financial, industrial, and healthcare verticals.
The Almarai counter in a typical Saudi corner store
|1. Brookfield Asset Management||1. Berkshire Hathaway|
|2. Denbury Resources||2. Big Lots Inc.|
|3. Google||3. Denbury Resources|
|4. HCC Insurance Holdings||4. HCC Insurance Holdings|
|5. Loews Corp||5. Horsehead Holding|
|6. Lukoil (OAO)||6. Markel Corporation|
|7. Markel Corporation||7. Schweitzer-Mauduit International|
|8. POSCO||8. Thor Industries|
|9. Telefonica SA||9. Trimas Corporation|
|10. WellPoint||10. Under Armour|
|11.Yum! Brands||11. WellPoint|
|Percentage of the Independence Fund in Top 11 Stocks: 30.0%||Percentage of the Great America Fund in Top 11 Stocks: 38.1%|
|Percentage of the Independence Fund in U.S.-based assets 56.5%|
But it’s not all puppies and kittens in Saudi Arabia. Like most frontier and emerging markets, Saudi Arabia needs better infrastructure to serve its people as well as inland businesses. Further, reliance on one major export -- oil -- subjects the country to sharp cyclicality. And finally, the country’s strict religion likely deters knowledge workers from the country -- and shackles half of the country’s workforce. (That would be the better half.) As Saudi Arabia modernizes to more and more resemble neighbors such as Dubai and Qatar, it will undoubtedly experience growing pains. (Shoot me an email at email@example.com and tell me which will happen first: The Communist Party falls in China or Saudi women remove the abaya. We’ll share the results in next month’s letter!)
As long-term investors, however, we are willing to put up with those pains so long as we benefit from compelling long-term progress. With a large and growing population, an economy backstopped by a valuable global commodity, and a variety of surprisingly well-run companies, Saudi appears to offer just that. Look for us to continue adding to our funds’ exposure to the country and the region in the coming months and years.
1. Before I make Saudi Arabia sound too provincial, I want to note that I was pleasantly surprised by how warm and friendly everyone we met was -- including both business contacts as well as strangers on the street.
2. While we don’t normally consider ourselves short-term investors, it’s interesting to note here that Saudi regulators are considering opening up the market in the first quarter of 2012 to foreign investors who at present must use instruments such as participatory notes, or P-notes, to own shares (as we do). Not only will such direct access likely attract foreign capital, but it makes the market eligible for inclusion in MSCI indexes, the indexes on which so many ETFs are based. That, dear Fools, is a potential short-term catalyst since foreign money in the market would undoubtedly drive up valuations.
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