Iran: huge potential in the world’s final major frontier

The West’s historic agreement to end the sanctions programme against Iran is poised to provide a huge boost to the Iranian economy

The Tehran Stock Exchange, established in 1967, has 316 constituents – with a US$26bn free-float on a total $103bn market cap . Without any foreign participation, the market on average trades $100m per day , but has been as high as $400m. It could make up 25% of the MSCI Frontier index if it were to fully open up to foreign investors .

While much more water must pass under the bridge before foreign access is granted, Iran clearly has some attractive investment fundamentals. It is possible to think of it as a post conflict economy, without the associated infrastructure damage. As such, we may see GDP growth accelerate much faster than many currently expect.

Iran has a population of 78m and is one of the most populous countries in the Middle East, at a similar size to Egypt and Turkey. Iran’s young demographics, with 64% of the population below the age of 35, promise a strong engine for growth over the longer term . Unlike a number of the other frontier economies we follow, the country’s population is also well educated, with over 4 million university students (50% are women) and a literacy rate for the key 15-24 year old group at 98%. In addition, Iran’s urbanisation rate is one of the fastest globally, rising from 27% to 71% in the last 50 years .

A diverse and cheap local market
At first glance, the Iranian equity market is cheap relative to global peers, trading at a forward P/E of about 5.7x . It offers a very diverse set of industries and companies, largely split across two sector groups.

The first is the commodity-focused companies – such as miners, petrochemical companies, energy and refineries. The other half of the market contains more consumer-oriented names – including banks, telecom, pharmaceutical and auto companies.

The largest stocks are Persian Gulf Petrochemical Industry ($9bn market cap), Mobile Telecommunication Company of Iran ($3.7bn), Tamin Petroleum & Petrochemical Investment ($3.6bn), Mobarakeh Steel ($3.5bn) and Parsian Oil & Gas Development ($3.4bn) .

Second derivative beneficiaries
We are very excited by the huge potential of Iran and the Iranian market, but there are still a number of hurdles to overcome. Assuming these are cleared over time, we will seek the highest quality growing companies to invest in. In the meantime, we are looking elsewhere for the countries and companies in line to capture the benefits of a resurgent Iran.

The United Arab Emirates looks to be a big beneficiary. Prior to the recent sanctions, Iran was one of the UAE’s largest trading partners, Iranians were major investors in Dubai property, and Dubai was a key destination for Iranian tourists.

On the corporate front, Irancell is one of only two mobile phone companies operating in Iran, with a 46% market share. Irancell is a subsidiary of MTN in South Africa, making up 14% of its latest net income . Another beneficiary will be Saudi Arabia’s Savola, which has about 40% of its edible oil production capacity in Iran, making up 13% of group revenues .

The development opportunity
Iran vies with Russia for the world’s largest hydrocarbon reserves, yet investment in production has suffered substantially under sanctions and now accounts for less than 15% of the economy. Production in the 1970s exceeded 6m barrels a day, compared to less than 2m barrels today.

In addition to oil and gas, Iran has substantial deposits of copper, iron ore, chromium, zinc and lead. It is also the leading regional cement producer, with 70m tons of capacity .

On the consumer side, we see major prospects as the economy normalises, access to technology improves and companies begin to invest. There is an opportunity to capitalise on country’s high mobile penetration and translate it into high broadband take-up, which currently stands at just 9%. Its formal grocery penetration of less than 20% could increase substantially as well, to move more in line with other emerging and frontier peers. We could also see local production of vehicles rise above the current level of 1.5m .

Finally, Iran’s financial penetration at 90% is high amongst frontier nations, but domestic credit to GDP now stands below almost all global peers – collapsing from 35% in 2007 to 10%.

Oliver Bell – manager of Middle East & Africa Equity SICAV and Frontier Markets Equity SICAV funds – T. Rowe Price