Iran: A giant prospect on the horizon
Iran looks likely to be reintegrated into the global community after the question of nuclear proliferation has been resolved. Joseph Mariathasan looks at what the opening of one of the world’s largest inaccessible economies could bring
“Some investors may find that a country with nearly 80m inhabitants, a $400bn (€356bn) economy and the world’s fourth-largest crude oil reserves presents interesting opportunities, just as Russia did in the first few years after the collapse of the Soviet Union,” says George Hoguet, Global Investment Strategist, at State Street Global Advisors (SSGA).
He goes on to add that Iran constitutes one of the largest economies in the world that is inaccessible to global investors. “Once it becomes legally possible to invest, then Iran would become a very compelling market to have exposure to,” says Asha Mehta, portfolio manager at Acadian Asset Management. The speed at which the US is negotiating a more normal relationship with Iran suggests that investors globally, US as well as European, should start looking at the opportunities and problems that an investable Iranian stock presents.
The possibility of sanctions disappearing and Iran opening up is significant on several levels. Erik van Dijk, the chief investment officer of LMG Emerge, argues that it would represent the first and most likely only time this century that a closed economy of this size will open up to the rest of the world. “Moreover, it has a diversified economy that has developed with a breadth that is unknown anywhere else in emerging and frontier markets” says van Dijk.
Valuations in Iran are absurdly low says Mehta. But they may be justified given that fundamentals in Iran are relatively weak. “Historical price/earnings ratios are around six, representing a 40% discount to what we see in emerging and frontier markets, and dividend yields are high at 14%. But interest rates are high with relatively limited growth prospects and concerns from companies arising from the hurdles imposed by a closed market. Where we see opportunities is through liberalisation and not just of the stock market.”
The potential for expanding Iran’s oil industry is tremendous, argues Hoguet. “During the days of the Shah in the 1970s, oil production peaked at over five million barrels per day [bpd] and currently it is less than three million bpd. Production has fallen substantially because of sanctions. It will take time to ramp up but will give them a substantial cashflow and attract a lot of foreign investment from China and Russia. It would also relieve some of the energy-constrained pressures in the global economy.”
“Once it becomes legally possible to invest, then Iran would become a very compelling market to have exposure to”
Investing in Iran is not only an oil story. Agriculture, manufacturing and mining are also key drivers of growth, says Mark Mobius, executive chairman, Templeton Emerging Markets Group. His team is particularly interested in consumer-oriented stocks as potential investment opportunities, which include retailers, food producers, telecommunications, financials and banking companies.
“Iran’s banking sector, in particular, could benefit, as the need for capital in Iran will be most acute,” says Mobius. “We believe this area – driven by domestic population growth, demographics and increasing disposable income – should be among the first to benefit from a potential removal of sanctions.”
Mehta also sees that foreign direct investment in sectors such as telecommunications, supermarkets, other consumer goods and the ability to export could meaningfully change the dynamics of the country. Van Dijk agrees. “Iran, in an open world, will also most certainly start to play a role as a regional economic powerhouse for customers in Central Asia, India, Pakistan, the Middle Eastern countries, and Turkey given the education levels, size and growth of its population.”
Mobius would also anticipate some re-investment of oil wealth back into the domestic and neighbouring economies. This would mainly take the form of much-needed infrastructure investment and diversification projects that aim to move economic dependence away from oil.
Corporate governance is a key question for most investors. Once international sanctions are lifted the International Financial Corporation (IFC), an arm of the World Bank, is likely to be an important investor. As its chief investment officer Jean Marie Masse explains: “Corporate governance is a key component of our due diligence process. We have a specialist team looking at critical issues such as protection of minority shareholders, quality of management and board members and the operational activities of the company. We undertake analysis pre-investment and then have an on-going monitoring programme post-investment.”
But for investors in listed equities, Mehta says managers are constrained by the lack of available information: “We do see leverage is very high in many companies and we would want to see the approach to leverage. Around 75% of companies in frontier countries use one of the big four accounting firms. They don’t have a presence in Iran currently so we would need to gain comfort in their accounting statements and how they are put together. We would also be concerned about investor relations – how much transparency there is, and how much access we would have to management teams. In Saudi Arabia, we have seen a lot of progress on this front in the last five years.”
Van Dijk is more relaxed on potential problems. “Iran is an Islamic republic. Governance under Islamic finance definitely exists and, although not as well developed yet as in major Western nations, it is more of a problem of things being done differently than things being dominated by corruption as we often see in other frontier and emerging markets”.
Van Dijk argues that the moderates in the Iranian government do understand the need of foreign investors and are trying to work on solutions that make the country more attractive. However, the shariah framework of Islamic law provides certain constraints and they have to take into account the position of hardliners.
“The result is that governance issues are definitely an issue to monitor closely, like in all frontier market and emerging market countries. But they are not so severe that Iran – and in a similar fashion its Sunni regional competitor Saudi Arabia – are not investable. We have seen worse situations in some African and Latin American countries.”
While the political tensions in the US/Iran relationship are unlikely to disappear quickly, there is pressure within the US to relieve sanctions. “Boeing does not want to see Airbus come in and take all the orders. US firms do not want to be left out of the action,” says Hoguet. For institutional investors, deciding on whether Iran is suitable for investment may be an question to consider sooner rather than later.
Iran: facts and figures
• The size of the Iranian economy in 2014 was $400bn at nominal exchange rates (World Bank estimate).
• Iran has a young population, with a median age of 28.
• Income per head is $5,300 at market exchange rates, roughly on a par with Peru or Jordan. On a purchasing power parity basis (adjusted for local price levels) it is $16,300, which exceeds that of Brazil. But 18% of the Iranian population is below the poverty line.
• Services represent about 50% of output, industry 41%, and agriculture 9%.
• Exports account for 23% of GDP.
• Iran is a major hydrocarbon exporter. It produces 3.7m barrels of oil per day (bpd), and exports 1.2m bpd and hopes to increase oil exports to 2.3m bpd in the event sanctions are lifted.
• Over the past three years, the nation has run a current account surplus in excess of 5% of GDP.
• Iran’s foreign exchange reserves stood at $110bn at the end of 2014.
• Iran is a net creditor in the international system.
• Tehran Stock Exchange has 440 companies listed with current stock market capitalisation of about $100bn. The free float is about $30bn with some percentage limitations placed on foreign owner-ship. Iran’s stock market capitalisation is below 30% of GDP.
Source: George Houget, SSGA