Sturgeon Capital report for the month ended December 31, 2015 titled, “Iran Strategy.” We previously reported about Sturgeon investing in Iran.

 

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[drizzle]Iran Deal[[Manager Commentary:

We are delighted to be sending out this inaugural monthly manager report for what is one of the first foreign investment funds actively investing in Iran in partnership with Mofid Securities, the largest broker in Iran.

Sanctions

Saturday 16th January 2016 marked an historic day for the Iranian investment landscape and international investors alike. The International Atomic Energy Agency (IAEA) verified that Iran had met its obligations under the Joint Comprehensive Plan of Action (JCPOA) leading to “Implementation Day” and triggering the easing of many of the long standing sanctions imposed against Iran by the US, EU and UN. Practically this has had the following implications for Iran and Iranian businesses:

  • Iran can now freely sell its oil in the international market;
  • Most Iranian banks can reconnect to the SWIFT network meaning the country can get paid for oil sales and businesses/citizens can again transfer money internationally through the banking system. The SWIFT reconnection is expected to be completed by the end of January 2016;
  • Sector sanctions are lifted, including banking, insurance, automotive and petrochemical sectors;
  • Non-US businesses/citizens will no longer be penalized by the US for doing business with Iran.

While the lifting of the vast majority of sanctions has indeed made investing in the Iranian markets much easier and has broadened the investment universe substantially, it is important for investors to understand that certain sanctions are still in place. The sanctions lifted on Implementation Day relate to nuclear proliferation and were the ones that were intended to have the most significant impact upon the Iranian economy. Sanctions related to human rights violations and links to terrorism still remain. Practically this means that doing business with the Revolutionary Guard (IRGC) or any related entities remains prohibited. From an asset management perspective this means that the Fund cannot invest in any company controlled by the IRGC. In terms of the listed equity market, the IRGC control or are linked to 4 large listed companies, otherwise its influence primarily extends to non-listed enterprises.

From a US investor perspective primary sanctions remain, meaning US businesses (with the exception of those in the aviation sector) still cannot do business with Iran. However, secondary sanctions have been lifted meaning that non-US businesses/citizens doing business with Iran will no longer be penalized by US authorities.

What Does This Mean for Iran?

  • Access to substantial funds frozen abroad under the previous sanctions regime. The estimates of the value of these funds are wide ranging. Critics of the deal claim Iran will now receive a windfall of more than $100bn. The US Treasury puts it at around $50bn, while the Iranian Central Bank puts the figure at $33bn. These funds will go a long way in helping the government to keep a stable currency and re-invest in the economy.
  • Access to international oil markets for Iranian oil and the ability to be paid the proceeds directly as opposed to payment being held in foreign accounts as was necessary under the sanctions regime. In 2015 Iranian oil production averaged 2.8 million barrels per day. The government has stated that it is targeting an additional 500,000 barrels per day increase on average for 2016, rising to a daily production of 3.8 million barrels for 2017. Even at these low oil prices this substantial increase in oil revenues will allow significant fiscal flexibility for the Iranian Government.
  • Iranian businesses are now able to access international capital markets and financing. For many industrial companies, this will have a dramatically positive impact as the manufacturing equipment required to increase production is not produced in Iran and up until now could not be purchased from abroad.

Slowly Iran will once again become a country that the international community can do business with. After a decade of harsh international sanctions substantial investment is required across all sectors, presenting numerous opportunities in both the short and long term for the Sturgeon Central Asia Fund Iran Strategy to capitalise upon.

Sturgeon CAF Iran – What Does This Mean for the Fund?

Being one of the first foreign funds post-JCPOA to invest in Iran we have already been actively investing in the Iranian equity markets since 1st December 2015. In order to ensure sanctions compliance our investment universe was necessarily restricted to around 50 companies of which 10 are now in the Fund portfolio. With the lifting of sanctions the investment universe has widened to include the whole of the stock market, with the exception of the four entities controlled by the IRGC. Four additional names are being added to the portfolio which were previously sanctioned and we are currently analysing several other potential opportunities.

An Investment Strategy for a Changing Business Landscape

Whilst we share the optimism sparked amongst the Iranian business and investor community by the lifting of sanctions, we have deliberately structured the Fund and investment strategy so as not to rely on sanctions relief as a critical factor for the Fund to be able to be actively investing and operational. The general perception is that the lifting of sanctions will lead to immediate improvements in the economy but our view is more cautious in this regard. Of course there will likely be immediate and obvious benefits e.g. an increase in consumer confidence and investor sentiment, but the real and substantial microeconomic benefits will take much longer to play out. Furthermore, as an investor in Iran, the lifting of sanctions introduces an unknown factor which is seldom discussed i.e. a shift in the competitive landscape for local businesses that for a long period of time have never had to deal with significant international competition.

There are a number of industries that will inevitably be disrupted by the entry of foreign competition, regardless of any government intervention or protection such as tariffs, subsidies, etc. Given this we have a deliberate bias in favour of businesses operating in sectors which have a comparative advantage due to the fact that they are in Iran versus international competitors in other markets. One such example is the Iranian glass industry. Feedstock, (gas and soda ash) is the largest variable cost for a glass manufacturer, and both are abundant and cheap in Iran. With manufacturing wages in the Iranian market on par with those in Vietnam, the cost of producing glass in Iran is amongst the lowest in the world. One such company currently in the portfolio is achieving operating margins of over 40% and has maintained them for the past five years. In comparison, the five year average operating margins for two of the largest global glass producers, Owens-Illnois and Saint Gobain, have been 10.2% and 5.1% respectively. Moreover the company has increased capacity by 60% in the past 12 months. In the case of the Iranian glass manufacturing industry, the analysis suggests that the probability of disruption by new foreign entrants is very low.

In fact the effect of sanctions relief will most likely be a significant positive for Iranian glass manufacturers, providing new opportunities for the export of glass products to neighbouring countries. Foreign markets have only accounted for 4% of the company’s revenues this year.

We take the following

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