Iran: The Final Great Investment Frontier?

Courtesy of The Financial Times, a report on Iran:

Iran’s historic nuclear deal and the lifting of sanctions should bring the country back into the global community. For investors, it is being heralded as the return of the largest economy to the global system since the breakup of the USSR in 1991.

We recently went on a fact-finding mission to Iran prior to the lifting of sanctions. What we found was a real eye-opener and exposed many of our biases as wrong.

Iran appeared more like Turkey than Saudi Arabia – Tehran being a very cosmopolitan city with a much more liberal attitude than we expected, with women appearing fully integrated into society.

Importantly, the country is educated, entrepreneurial and asset rich, but remains cash-flow poor because of the sanctions that have been in place since 1979. With those sanctions being lifted, there is much to like as an international investor.

Iran is well documented to be the world’s largest holder of oil and gas reserves combined – at number four in oil and number one in natural gas. The IMF sees Iran boosting global oil production by 600,000 barrels per day in 2016, based on the rollback of EU and UN sanctions, with output rising to 1.2m bpd over the medium term. That would be equivalent to approximately half of global oil demand growth in 2016.

Iran also boasts a large and young population, with 60 per cent of people under the age of 30. Its workforce is well-educated, with the third-highest number of engineering graduates after the US and Russia. It also has the highest literacy rate in the Middle East and North Africa region.

As for the economy, Iran is the second-largest in the Mena region after Saudi Arabia, with gross domestic product of $406bn in 2014. This is roughly the same size as Thailand.

Now that sanctions have been lifted, the World Bank forecasts that real GDP growth could rise from 1.9 per cent in 2015 to 5.8 per cent in 2016 and 6.7 per cent in 2017.

In addition, Inflation has dropped from a peak of 45 per cent in 2012 to the low teens today due to tough monetary policy.

Longstanding state involvement and weak governance combined with several years of sanctions has left the banking sector in a relatively weak state. The banks we met with were heavily exposed to non-core assets in areas such as real estate, franchises and equities – likely to be due to restricted investment alternatives due to the sanctions.

The banking system does cause concerns as it is undercapitalised, with a high rate of non-performing loans, and there are no plans for recapitalisation yet. However, there is a lot of interest from foreign capital, and many of the Iranian banks are already talking to international banks.

The Tehran Stock Exchange operates two exchanges, with 540 listed companies on the main bourse, market capitalisation of $120bn, daily turnover of $40bn and a somewhat staggering 107 brokers. The daily limit up/down is set at 5 per cent. Exchange traded funds were launched in 2013, and 11 are currently listed on the TSE.

The index trades on a price-earnings ratio of 6 (having been as low as 4-5 times earnings) and a dividend yield of 14 per cent, but with negligible foreign participation.

A major government-led privatisation drive in 2006 put a wide range of companies back into the private sector. The 10 largest listed companies account for half of the TSE’s market cap, with seven of those having been registered as part of the government privatisation programmes.

The oil and mining sector dominates the economy and the stock market and is desperate for capital and foreign cooperation. There is, therefore, a narrow, rich seam to play in the stock market, and it may be a crowded trade.

We believe there is money to be made for first movers coming into the market in early 2016. Longer term, the road looks more uneven and the chances of having stranded investments is significant.

The purpose of the trip was to acquaint ourselves with Iran and its idiosyncrasies, which we have done in part, but need more time with companies and government officials to become truly comfortable investing.

Issues such as business transparency and corruption are also central in the development of any frontier economy: Transparency International’s 2014 Global Corruption Index ranked Iran 136 out of 175 countries.

However, interest in Iran will only rise because of its reintegration into the global economy, its huge hydrocarbon reserves and its positive demographics. Institutional investors, however, will probably face some challenges in areas of liquidity and corporate governance.

Challenges such as these are not uncommon as markets open up, and there are always areas for experienced investors to uncover neglected companies with healthy or improving operations.

Ultimately, with a focus on quality, investment in Iran could prove rewarding, especially given the starting point of very low valuations. In addition, with Iran being one of the last great frontier markets left to invest in, it could potentially provide one of the final pieces of the investment puzzle for some investors.

This entry was posted on Tuesday, February 23rd, 2016 at 9:51 am and is filed under Iran.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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Wildcats & Black Sheep is a personal interest blog dedicated to the identification and evaluation of maverick investment opportunities arising in frontier - and, what some may consider to be, “rogue” or “black sheep” - markets around the world.

Focusing primarily on The New Seven Sisters - the largely state owned petroleum companies from the emerging world that have become key players in the oil & gas industry as identified by Carola Hoyos, Chief Energy Correspondent for The Financial Times - but spanning other nascent opportunities around the globe that may hold potential in the years ahead, Wildcats & Black Sheep is a place for the adventurous to contemplate & evaluate the emerging markets of tomorrow.