The strategy focuses on investing in frontier and emerging market companies that our team expects will benefit from demographic trends, changing consumer behaviour, policy and regulatory reform and technological advancements.

Below, we explore several key factors influencing returns and share observations on the portfolio and the markets.

Internet and technology portfolio

Investments that we wrote about in previous letters, including Lithuania’s Baltic Classifieds Group (BCG) and Egypt’s Fawry for Banking Technology and E-Payments (Fawry), performed well in the quarter.

BCG is the leading online classifieds group in the Baltics with a dominant position in auto, real estate, jobs and services and generalist marketplaces in Lithuania and Estonia. The company’s shares rallied in the quarter as the market reacted positively to the exit of Apax Partners LLP, the private equity firm that brought BCG to market via IPO in July 2021. Private equity ownership of public companies can often lead to an overhang on the share price and liquidity in the market. Typically, incremental buyers are discouraged by the prospect of an eventual wall of shares hitting the market when the private equity owner(s) decides to sell, and liquidity is lower because a relatively large percentage of the outstanding shares is not freely floated. A high-quality business like BCG, whose revenues and operating profits grew approximately14% annually over the last 4 years, generally absorb this type of overhang on their shares as incremental buyers step into liquidity events with more confidence. This was the mindset with which we approached BCG and thus actively participated in Apax Partners’ share sales this year, ramping up our participation as they approached their exit sale in July.

Fawry is the leading payments technology company in Egypt. The business is anchored by a base of over 360k point of sale machines (POS) that enable merchants to accept payments for the sale of their own merchandise (e.g.: a carbonated beverage) or on behalf of other large businesses like telecoms and utilities. Fawry has leveraged its first mover advantage in POS by introducing value-added services to their merchants such as supply chain financing (i.e.: working capital loans), ATM (a consumer can take out cash from a POS using the merchant’s float at the till for a fee), payment acceptance across many services and agency banking where it acts as a distributor of bank products to underbanked merchants and consumers through dedicated branches that are branded FawryPlus.

Fawry’s merchant offering extends beyond brick and mortar; it is also a leading payment gateway enabling online payments between consumers and merchants and, in the process, captures a piece of the fast-growing e-commerce market in Egypt. On the consumer side, Fawry’s app (MyFawry) counts over 5 million downloads and is experiencing strong momentum, driven by the introduction of a wide range of use cases including bill payments, virtual debit card wallets, buy-now-pay-later, insurance and savings products. In an inflationary environment like Egypt’s, Fawry’s transaction-based revenue model means it can grow revenues at a faster rate than costs due to the operating leverage inherent in its business. This was evident in second quarter 2024 results with operating margins expanding by more than 6% compared to the same period last year. Fawry shares reacted positively to the results, and more importantly to management guidance on net income for the full year, which implied a growth of about 67% y-o-y in local currency.

Like BCG, Fawry shares also benefited from the exit of private equity firm Helios Investment Partners (Helios) from the company in the quarter. Helios has been pressuring the shares through open market sales. Like the BCG case, we took advantage of the liquidity event and were involved in a discounted clean-up sale in which Helios sold its remaining 5% stake in Fawry, which helped remove the overhang on the shares.

Healthcare portfolio

The strategy experienced good returns from the healthcare portfolio during the quarter, driven mainly by Morocco’s Aktidal Group (AKT).

AKT is the leading healthcare provider in the country with approximately 15% of the private bed capacity in the country. The Moroccan healthcare market is severely underserved, with the rates of beds and physicians per 1,000 persons below regional averages and well below WHO recommended levels. (A WHO study ranks Morocco 79th of 115 countries in doctors per capita.) This has severely curtailed investment in the sector, with private providers accounting for under 30% of bed capacity in the country of around 40 million people. To address this shortage, the Moroccan government embarked on a series of reforms including rolling out a universal healthcare scheme and removing a restriction that allowed only doctors to invest in the sector. AKT operates 2,532 beds in 23 sites spread across 11 cities.

The clinics managed by AKT are known for their quality of care and the strength of their oncology department (30% of consolidated revenue). AKT is at the forefront of the growth in the sector: its 2023 results which showed revenue and operating profit growth of 84% and 86% respectively. On a recent trip to Morocco, we conducted site visits and meetings with Moroccan doctors and competitors of AKT which validated the company’s brand and reputation in the market and highlighted the growth opportunity that lies ahead for the company.

BH is a premium hospital operator in Thailand, with one 580-bed site in Bangkok that provides premium healthcare services to affluent Thais, expatriates and medical tourists. Our thesis on BH rests largely on its medical tourism business, which contributes 55% of revenue and substantially more of operating profits. BH carved out a niche among patients from the Gulf countries (40% of medical tourism revenue), Myanmar (10%), Cambodia (7%) and Bangladesh (5%) and has built strong relationships with patients and payors in those geographies through a network of agents and direct relationships with ministries, embassies and consulates.

Thailand’s position as a top travel destination and its developed hospitality industry has allowed BH to offer a high-quality medical service with a pleasant recovery experience for their patients. Medical tourism is good business as it typically features cash or government payors who are seeking high revenue treatments that may not be available in their home countries or are prohibitive from a cost standpoint in countries like the US, Germany or even Singapore. Thailand’s cost advantage is therefore another area that BH has leveraged in creating a service that appeals to medical tourists and their governments. BH’s niche positioning and premium healthcare offering to this attractive segment is reflected in healthy operating margins of 33% and returns on invested capital of more than 30%. Recent data on Middle Eastern tourism to Thailand is encouraging (7% growth year-on-year in July 2024) and should support BH’s earnings into the second half of the year. We also expect BH to benefit from agreements between Saudi Arabia and Thailand, which can open the largest medical tourism market in the Middle East. Saudi patients represent a fraction of other nationalities that BH treats from the Gulf countries and so any progress in that market should diversify the patient base and support earnings growth in the medium term.

Outlook

We continue to be constructive on the opportunity set for the strategy as we enter the fourth quarter of the year. We believe we positioned the portfolio to be considerate of changes in the interest rate cycle, political environment and portfolio company valuations. As always, the ultimate objective of our decision-making process is to express our best research opinions through a diversified portfolio of high-quality businesses that we believe will help us deliver on the strategy’s return objective.

We look forward to continuing to update you on the strategy over the rest of the year.

MENA equity markets had a strong third quarter of 2024 with returns of 6.7% (for the S&P Pan Arabian Index Total Return) but trailed the MSCI Emerging Markets Index, which was up 7.8% in the same period. For the first nine months of 2024, MENA equity markets are up 5.4% compared to 14.4% for the MSCI EM Index.

Our team spent time in Saudi Arabia recently and came back feeling positive about the Kingdom’s medium-term prospects. The impact of the bold socioeconomic reforms that the country pursued in the last few years is visible not just in economic activity (and bad Riyadh traffic), but also in the sentiment expressed and captured in interactions we had with company executives, government officials, Uber drivers and hotel and restaurant staff. One can make the case that Saudi women have been the group that benefited the most from the country’s reform program. The elimination of the religious police establishment and lifting of the driving ban led to freedoms and mobility that Saudi women had not experienced before in their own country. This resulted in remarkable growth in their labour force participation, with data from the World Bank showing it had increased from 20% in 2018 to 35% in 2023. Much has been written about the changes that have been taking place in the Kingdom in the last few years, and we will not expand further on that here. However, we believe Saudi Arabia is in the early innings of a major societal and economic transformation project that will generate multi-year growth in profit pools in certain sectors like financial services, healthcare, education, entertainment, tourism, real estate and technology. Some of the profit pool growth will come at the expense of sectors that are not prioritized under the government’s Vision 2030 program or are not as geared to the evolution in consumer behaviour and evolving regulatory environment. These include brick and mortar retailers or companies that over-earned on government contracts, and which can be found in several sectors including construction and engineering.

Of course, not all is rosy in the Kingdom. While significant progress was made on diversifying the economy, nearly three quarters of the budget is still funded from oil revenue. If it stays, the current combination of low oil prices, production curtailment and high government spending is likely to weigh on growth or raise the risk of fiscal imbalances in the long term. The economic viability of some of the giga projects is difficult to determine and so poses additional capital allocation and fiscal risk. Positively, the country is preparing for this reality and has been actively diversifying its sources of funding from debt and equity capital markets. According to Fitch Ratings, Saudi Arabia was the largest US dollar debt issuer in emerging markets (ex-China) in 1H 2024. The listing of Saudi Aramco and the dividends that the government will receive from that will also continue to support the budget.

Additionally, inflationary pressures are building up in the system – specifically in Riyadh as demand- and supply-side factors collide in areas of housing and transport. This is resulting in downward pressure on household disposable incomes and is manifesting itself in downtrading and increased household debt. Unsurprisingly, many consumer companies are observing down trading in their revenue mix, and many are reacting through aggressive discounting to preserve market and wallet share. Consumers are embracing buy-now-pay-later financing to maintain or extend their purchasing power and this channel is becoming increasingly more prominent in the revenue of many consumer-facing businesses. Furthermore, consumer pressure in Saudi Arabia has the potential to delay further necessary reforms and regulations that can open new profit pools as the government looks to strike a balance between diversifying the economy and protecting consumer purchasing power.

The strategy has had good success investing in Saudi Arabia from identifying growing profit pools early on and investing in companies that were best positioned to grow their share of them. Those include companies we have previously discussed in our letters such as Saudi Dairy & Foodstuff Co. (SADAFCO) in 2018, National Company for Learning and Education (NCLE) in 2019, and The Company for Cooperative Insurance (TAWUNIYA) in 2023. However, there are several challenges that have impeded our ability to express a fuller position in some of the sectors mentioned above. Firstly, we view the quality of certain companies in sectors like real estate and tourism as relatively poor and place some of those in the over-earners group we describe above. The other dynamic that has been increasingly challenging to navigate is the valuation environment, especially with regards to growth stocks. In the last two years, the market moved well ahead of earnings expectations, creating an unfavourable risk-reward set-up for companies the strategy owned and prospected. Using the MSCI Midcap Saudi Index to proxy growth companies in Saudi Arabia, we find that the price-to-earnings (P/E) ratio in 2023 was 38 times, more than double the 2022 levels and above levels we believe reflect cost of capital and growth dynamics on the majority of stocks in that index. Of course, we have made exceptions where we maintain ownership of a few high P/E ratio companies only when we believe their quality and growth potential justify such valuations. While we strongly believe in momentum as a factor for driving returns and outperformance, valuation is the ultimate determinant of our capital allocation reflexivity.

Fortunately, there are three factors working for the strategy at the moment. Firstly, there are growing profit pools resulting from reforms and demographics which is critical to our investing style – growth. Secondly, in the last two months, the market has begun the long-awaited process of recalibrating its expectations of earnings to levels that we deem realistic and interesting – reasonable valuations. Lastly, the strategy has already begun shifting the portfolio to areas where there is a healthy combination of growth, risk-reward and low investor positioning. One particular area where the strategy has been net buying in is the Saudi conventional banks, where we believe technical overhangs have largely suppressed price discovery year-to-date. The set-up for next year looks particularly attractive as those headwinds become less pronounced and bank earnings continue to compound.

We look forward to continuing to update you on the strategy in the next letter.