Turkish Industrials: Buying Opportunities

In a recent note, we mentioned that now may be the moment to get in on value in Turkish stocks, particularly in industrial stocks. Following that, Borsa Istanbul Industrials Index (BIST:XUSIN) has bounced back 4.5% in two trading days, beating the banks, but currently see a sell-off (on Tuesday) but outperforming the broader market.

We think that the sell-off after the coup attempt created a buying opportunity. Hereby, we try to draw valid conclusions in a long-term perspective with the help of historical data and fundamental outlook.

First, returns over the past several years are in favor of our idea that industrial stocks should be opted for the upcoming period. Turkish banking stocks has suffered from an earnings recession recently, as well as the regulatory environment has been severe for the industry after late-2008 financial crisis which has weighed on global financial institutions.

Second, in our view, S&P’s ratings decisions typically act as a reserve proxy for Turkish stock market. Provided that the agency just downgraded the country by one notch, Turkish stocks might have entered a bull market. This is partly due to credit ratings persistently lagging behind market.

Turkish Stocks - Banks v Industrials - Reaction to S&P Rate Decisions

Below is list of our Turkish industrial picks.

Turkish Industrial Stocks

And below we provide EV/EBITDA metric for the stock that we analyzed, comparing the current level to the historical average and +2 (-2) standard deviations. Most of the stocks currently look cheap and undervalued across the metric.

Turkish Industrial Stocks EV EBITDA Valuations

Akcansa (BIST:AKCNS), a building materials company and a subsidiary of Sabanci Holding (BIST:SAHOL), in our view, has compelling risk reward profile thanks to its exposure to Istanbul region, its resilience in a potential volatility in cement prices, and its cost outlook taking the pressure off.

Arcelik (BIST:ARCLK), has pulled out a great financial performance in 1H16 owing to a decline in raw material prices, but more importantly to a surge in TV sales ahead Euro 2016 and Summer Olympic Games. The company has now a significant share in European markets and solid growth prospect for the future.

Aygaz (BIST:AYGAZ) enjoyed the strong domestic demand for LPG last year which is not likely to sustain this year, still, the stock is trading at a significant discount from a historical point of view. Thus, we recommend investors to consider it who are willing to build position in Turkish equities with a long-term perspective.

Eregli Demir ve Celik Fabrikalari (BIST:EREGL) has been one of top-traded industrial stocks in Turkey and always offer value to traders who’s looking at this part of the world. As an iron and steel producer, the company faces risks arising out of ups and downs in raw material prices, and always benefits from its structural advantages including not being a vertically integrated producer and hosting ports in its plants.

Ford Otomotiv (BIST:FROTO) has poised for strong EBITDA growth over the next three years as the investments that the company made earlier are starting to pan out. The company hit the gas pedal with the management guiding for almost 100% capacity utilization during this timeframe. Still, the UK remaining in recession longer than expected poses risks for sales as it is the top market for the company. With that being said, the stock is currently trading below its mid-cycle average, creating a big opportunity to get in.

Turkish Industrial Stocks - Emerging Market Peers Multiple Comparison

Kardemir Karabuk Demir Celik (BIST:KRDMD) is trading at 35% discount to its book value and appears like a deep value play.

Tofas Turk Otomobil Fabrikasi (BIST:TOASO) is another company in Turkish autos spectrum that is set for full capacity thanks to newly introduced sedan models which will build a supportive case for our growth story.

Turk Traktor ve Ziraat Makineleri (BIST:TTRAK) received a number of upgrades by the analysts with the help of strong demand boosting the sales in 1H16. Declining interest rates will provide further support for the bottom-line growth.

Tupras Turkiye Petrol Rafinerileri (BIST:TUPRS) has sustained the best-in-class margins, showed operational excellence and proved to be a prominent play in emerging markets E&P universe.

Pakistan: An Attractive Frontier Market Pick in Asia

Macroeconomic Outlook

After years of full of challenges, Pakistani economy is now out of the woods with high-single digit GDP growth rates projected for the upcoming two years. Even if the country still faces some significant political risks and has some vulnerabilities due to high indebtedness, we believe the provided risk-reward profile is very compelling at this point.

Pakistan is one of the few frontier markets that are expected to receive a credit rating upgrade this year. As of now the country is rated as B-by Standard & Poor’s with positive outlook with opportunities and risks recognized.

Pakistan GDP Growth and Sectoral Composition

This year is crucially important for Pakistani economy as about 40% of the country’s outstanding debt, which amounts to $45 billion, is due to mature in 2016, of that $41 billion is in local currency. However, we believe that existing IMF funding and the Chinese investment in an economic corridor will offset the pressure as we see no reason to panic for the outlook of the economy.

The government embarked on a number of reforms, many under the aegis of an Extended Fund Facility (EFF) arrangement with the IMF, which included strengthening the State Bank of Pakistan (SBP, the central bank) autonomy through an establishment of an independent monetary policy council for rate setting. Following that, an interest rate corridor was introduced with a ceiling rate of 6.5% and the floor rate of 4.5%. Given the core inflation prints in 3-3.5% range and Pakistani Rupee trading in the narrow range of 104-105 for the past year, the improved monetary transmission mechanism has been successful to stabilize the economic indicators, which will lead a less hazy economic outlook and lower fundamentals risks.

Secondly, The China Pakistan Economic Corridor (CPEC) is a $46 billion FDI pledge from China which will serve as a catalyst for increased economic growth as well as risen geopolitical interest from other countries. Some other counties including Russia, the UAE already announced billion dollar mega projects. Eventually, we will be able to see infrastructure developments needed to boost the economic growth in the long-term which the country has lacked for years.

At the end of 2015 total public debt to GDP ratio stood at 61.5%, showing an improvement of 20 basis points y/y. Meanwhile, total external debt and liabilities rose to 7,2 trillion rupees which amounted to 23.4% of GDP. Having improved its risk profile, Pakistan could have managed to lower its borrowing costs from global financial markets. Moreover, in domestic credit markets, we saw the average rate for outstanding loans in Pakistani banking system coming down to 8.58% in February 2016 from 10.59% in the same month of 2015, while outstanding rates for deposits lowered to 5.03% from 6.7% within the same timeframe. Thanks to the stabilized inflation rates and the new monetary policy framework, we foresee the continuation of the benign trend in the credit markets.


Pakistan - Karachi Stock Market Performance versus Emerging Asia ETF

Founded on September 18, 1947 in Karachi, the largest city of Pakistan, Karachi Stock Exchange has more than 650 companies listed with total market capitalization of $72 billion. It ranked third in 2014 amongst the top ten best performing markets in the world according to analysis by Bloomberg. Our views on specific sectors are as given by.

As discussed above, the ongoing trends in credit markets are in favor or banks. Not surprisingly, total assets grew by 17% system-wide last year, reaching a record level of 14,143 billion rupees (investments and advances grew by 30% and 8%, respectively). In such a growth period, NPLs only totaled 11.4% of total loans (12.3% in 2014). Moreover, Pakistani banks built provision that covered 85% of total NPLs, lowering net NPL ratio to 1.9%. Despite the fact that credit metrics were still not good, banks showed a major development in terms of quality. Commercial banks averagely recorded a ROE of 25.8% when tax excluded up from 24.3% in 2014, as they posted a Tier-1 ratio of 13.1% for full-year 2015, up from 12.9% in 2014. Thanks to increasing profitability and strong capital structures, we are of the opinion that Pakistani banking stocks provide a good environment for not faint-hearted investors looking for opportunities in frontier Asia. The following is our picks from Pakistani stocks.

Pakistan - Stock Selection

We believe that Pakistani banking stocks offer attractive value, thus we pick four of the banking stocks with the greatest market cap. Additively, we add an industrial to the list, Lucky Cement, which, we believe, solidifies our portfolio with an outlook for increased spending on construction materials due to the infrastructure deficit and its rarely seen profitability metrics.