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.

Turkey: Any Room for Loan Growth?

Turkish central bank cut its overnight marginal funding rates by 75 basis points in the past two monetary policy meetings in an effort to simplify its interest rate structure as the volatility in global financial markets eases. The rate cuts came amid criticism by the government over high interest rates limiting the economic growth. With year-end inflation expectations around 8% and the central bank’s average funding rate of 8.5%, one would call the current stance of the central bank extremely dovish, however, it still fails to boost bank lending which is believed to bring economic expansion with increased investments, according to the top politicians of the ruling AK party.

The central bank sees the current loan growth in Turkey at reasonable rates, correspondingly, in harmony with its macro prudential measures, and views structural reform measures by the government as the needed policy tools to boost potential growth. Previously we stated that Turkish central bank seemed to lose its ability to impact interest rates in credit markets as the divergence between the loan-deposit rates and the policy rate became strikingly visible. Another issue we mentioned was the skyrocketing loans-to-deposits ratio making the financial system increasingly vulnerable. This would suggest a weakness in banks’ tendency to pump up more funds into the economy to a certain extent despite the growth-friendly rate environment. On the other hand, we saw the state-run banks still recording above industry average loan growth which has been completely in line with the government’s strategy.

Turkey - Lending Growth

As expected state-run banks in Turkey has outperformed their privately-capitalized peers in Turkey by a substantial margin over the past three years in related to the lending growth as they have increased their market share from 23.3% in March 2008 to 32.8% in February 2016. Not surprisingly, loans-to-deposits ratio has been higher in state-run banks that that of the industry.

Turkey Loans to Deposits Ratio

With aforementioned points made, we are very likely to see the banks’ deposits book on conditions that easing inflationary pressures and less volatility in exchange rates. Then, Turkish financial institutions would have stronger funding base to finance the lending growth. Yet, any unexpected easing steps from Turkish central bank would prevent these conditions from being fulfilled.

Loans to Deposits Ratio in Emerging Economies

In terms of lending capabilities, Turkish banks are still in a better condition than some of developing economies. However, it is the only country with a loans-to-deposit ratio above unity that saw an increase between 2011 and 2015. Moreover, majority of the emerging markets have seen decrease during the same timeframe. Going forward, we believe that external debt will continue to build a scenario full of funding challenges for Turkish banks.

Turkey vs Emerging Economies: GDP Comparison Throughout History

Even if a number of pundits have the opinion that emerging economies can likely withstand a Fed rate hike, it would absolutely matter for all as investors have already began to flee with the tightening in financial conditions. On the other hand concerns about emerging market fundamentals have risen with the news signs of China’s slowdown that has intensified fears that the ongoing emerging economies growth deceleration is not over yet. This unsurprisingly led downward revisions to growth projections.

The past decade’s pattern of nearly all emerging economies growing quickly was a historical anomaly fed by easy money. At this stage it would be a horrible mistake to look at emerging markets as a homogeneous asset class as desynchronized cycles offer great investment opportunities once a selective approach is employed.

Further divergence within emerging economies is likely to continue to be a major theme and the existing divergence in the pace of GDP growth across those economies will widen primarily due to continuing downward pressure on commodity prices, the influence of divergent monetary policy, and differing degrees of success from structural reforms in each economy.

Turkey has been an emerging market star over the past decade. However things seem to change after all with rising risk sentiment. With regard to this it would be a useful tool to determine how the country actually has performed during the golden era of developing economies in light of the past macroeconomic performances.

Turkey - Emerging Economies - GDP Comparison

The chart above shows the real GDP growth differential between emerging economies and Turkey based on annual growth rate. Apparently Turkey has been able to outperform its peers in 4 out of 11 years researched (6 out of 11 when China excluded). More importantly Turkey simply acting like a high beta market during the period of low growth would foreshadow the possible outcome of the next slowdown era.