Investing in Iraq: A Frontier Market Too Far?

Financial Times, March 7 2014

There are frontier investment markets, and then there is Iraq. Bombings and fighting killed at least 42 people on Thursday alone, in nine or more separate explosions from Baghdad to Fallujah; yet so commonplace is the violence that the news merited few headlines. After all, at least 24 had died in explosions the previous day.

Yet despite the violence and uncertainty, fund managers and bankers are venturing in to the country, attracted by oil wealth and a surprisingly upbeat outlook for national GDP growth.

On Friday FMG, an emerging market and frontier research group, put out an investment report on Iraq, arguing that: “There is another more promising side to Iraq.”

In the past decade, the report notes, Iraq has tripled its oil production, posted GDP annual growth rates of around 10 per cent, and seen the market capitalisation of its stock exchange almost triple in three years.

FMG is not alone in noting this: Iraq’s own central bank is expecting 9.4 per cent annual growth in GDP to 2016, Bank of America Merrill Lynch has said the economy could triple in size by 2024, and Citi has predicted it could become a $2tn economy by 2050, as the country becomes one of the largest oil exporters worldwide. The IMF has said Iraq could gain almost $5tn in revenues from these oil exports between now and 2035.

From the investor perspective, the question is how to play it. Economic projections like that are all well and good, but how can they be realised against a background of bloodshed?

The cold reality is that the violence hasn’t had an impact on the behaviour of equities. FMG argues that over the last five years, nowhere has shown faster EPS growth rates than the Iraq Stock Exchange, although it has not yet been reflected in share prices. “We are of the view that Iraqi equities have potential for one of the greatest rallies in the developing market universe,” the report says.

As it stands today, the stock market is dominated by telecoms and banking. Out of 82 listed companies in Iraq, 21 are private banks, and this is an example of where FMG sees opportunity. It says profit before tax was up 29 per cent CAGR between 2007 and 2012 in the banking sector, yet quality banks trade between 1 to 1.5 times book value. Only 15 per cent of Iraqis have bank accounts, giving room for growth, and in a largely state-dominated sector (Rashid Bank and Rafidan Bank, the biggest, are both state-owned), the private banks are starting from a low base of just 10 per cent of the industry’s assets. FMG highlights Mansour Bank as an example of a good opportunity, having improved net income 115 per cent last year.

Although local investors account for 90 per cent of the modest daily volume on Iraq’s bourse, the market has received greater international attention ever since the listing of Asiacell last year, the largest company to be floated in the Middle East since 2008. That company now has 11m subscribers and offers a 5.5 per cent yield, but is on a trailing P/E of just 7.7 times.

The argument against investment is that the political situation may get worse before it gets better: a parliamentary election is due, and unrest is unlikely to ease ahead of it. The level of violence that has characterised the start of the year is the worst the country has seen since 2008.

Aside from frontier fund managers – the Euphrates Iraq Fund, Invest AD Iraq Opportunity Fund and Sansar Capital’s Frontier Fund being further examples – other financial services businesses are looking closely at Iraq. In October, the FT reported that Citigroup, JP Morgan and Standard Chartered were all planning to open bank branches in Iraq, and in 2011 reported that Morgan Stanley, Goldman Sachs, HSBC, Citi and BNP Paribas were sending bankers to Iraq to pitch for advisory work, underwriting and project finance. HSBC and Morgan Stanley led the Asiacell IPO, while Zain Iraq, which is expected to list this year, appointed Citi, BNP Paribas and National Bank of Kuwait as advisors on the listing several years ago.