Turkish banks are up 3.5% on average year-to-date with tailwinds from a better outlook for 2016 and easing regulation standards. However, since last year, Turkish banks have performed remarkable worse in a MENA context. The “exciting” period regarding the political risks and the continuation of downward trend in profitability were the key reason for the exceptionally weak performance.
This year has signs of relief for the industry with strong projected EPS growth figure after a tough year. Even if the most banks guided prudently on volume growth and asset quality for 2016, the bottom line are likely to improve with the help of higher fee income and lower operational expenses. That said, Akbank (BIST:AKBNK) remained as the most optimistic lender with aggressive growth expectations for the upcoming period. Easing regulations will somehow help all the banks to growth their businesses and to record lower provision expenses despite some NPL additions in the horizon. Having said that, accelerating earnings growth is enough to make a permanent optimist, as expected ROEs would still be held back this year.
I continue to prefer Akbank (BIST:AKBNK) and TSKB (BIST:TSKB). I believe Akbank is set for profitable growth in 2016 and should perform relatively better than its peers. TSKB is still a defensive pick against foreign exchange volatility and its top line will be supported by stronger CPI-linker revenues this year.
Turkey’s Gross Domestic Product expanded 2.6% in 4Q14, higher than the market consensus of 2.1%, bringing full year growth to 2.9%, compared with an upwardly revised 4.2% a year earlier. Stronger than projected stock drawdown was the key driver of the deviation from the consensus. The contribution of net exports and investments to GDP growth was negative. The data also suggested that the pace of economic activity slowed considerably in 2014, as the country has been facing quarters of sub-par growth.
Private sector investments continued to be the weakest part of the country’s GDP, as public sector investment expenditures had not been able to offset it. Investment spending decreased by 1% in 4Q14 (meaning a negative contribution of -0.3% to GDP growth). Private companies’ investment in machinery declined 3.7% in 2014, while the public sector’s purchases of equipment and spending on construction shrank 8.8%, according to the official data. On the other hand, household demand, which makes up two-thirds of GDP, grew 1.3% in 2014, compared with 5.1% in 2013. The drop was attributed to shocking rate hike in January 2014, and to the rising unemployment.
The agricultural sector posted a 2% contraction in 2014. In contrary, financial services industry posted a robust 7% growth on annual basis. The industrial breakdown of Turkey’s GDP is as follows.
There are questions to be considered mostly driven by slowing private investments, as the achievement of a sustainable growth rate appears doubtful in Turkey. Additionally, widespread loses among the leading indicators continue to point to a disappointing growth in the short-term. For instance, Purchasing Managers Index, or simply PMI, the manufacturing leading, is down to 48 in March showing a contraction. The reading has been on a declining trend since December 2014, and below 50 for the first three months of this year. The industrial production index was down to 112.26 from 130.3 in January. On the consumption side, the consumer confidence index drastically fell to 64.4 in March which was the worst print since the global financial crisis. In a nutshell, the 4Q14 GDP data did not provide encouraging signals, so did the leading indicators.
In a previous article about inflation, we noted no responsive policy implications by Turkish central bank after the worst March print since 2003. For this reason, we still expect the central bank to remain cautious, and more fiscal policy tools to be used for stimulating the economic growth.
As I noted earlier, Turkish stock market is mostly driven by a bunch of large-cap bank stocks with high levels of trading activity. Under these circumstances, developments in the industry becomes crucially important for any investor holding Turkish assets. Hereby, my aim is to mention some important points by using some valuation metrics in historical perspective. In this analysis I have a narrow scope consisting of six top trading bank stocks which in fact is big enough to cover and to fully understand the undergoing stock market trends. These stocks include Akbank, Halkbank, Garanti, Is Bankasi, Yapi Kredi and Vakifbank.
The chart below shows how has the market cap weighted price to book value of under-researched companies evolved for the last five years. Turkish bank stocks seem to be cheap at first glance on historical basis. For the last five years they have averagely traded at one and a half times their book value. However, September 2010 was a significant turnaround in the valuation of banks where an average a P/BV over 2.3 was observed. Therefore, I minimized the period that the chart covers to three years to able to obtain more meaningful results. Once more, the recent valuations are slightly below the historical average.
The premium valuations certainly require high profits, there is no doubt about that. At this stage it would be helpful to check the reported financials to see if the valuations prove to be right. Return on equity which is a central measure of performance in the banking industry is what I intend to focus here. That said, it is the most widely used metric to predict the future P/BV.
As of the end of 2014, market cap weighted RoE in selected bank stocks seems to hit the dip in under-researched period. This presents some important findings. First, below average valuation on historical basis is simply fair as the profitability of industry has taken a huge hit starting mid-2014. Second, aside from being fair, the valuation may even be optimistic as they are still near their historical average. This may also be due to Turkey’s macroeconomic fundamentals perceived as less risky by investors, like lower blended risk-free rate for the local currency, or lower market risk premium.
The second finding I mentioned above take us to paint a picture of future for Turkish bank stocks. Frankly speaking the level of profitability across the industry does not help us paint a rosy one for upcoming months. What is worse, United States Federal Reserve’s policy tightening will absolutely hurt the capital inflows to emerging markets and result in gloomier macroeconomic outlook for them. This eventually will cause a substantial increase in perceived risk. Will Turkey’s banks reporting lower revenues and income still be able to attract investors’ attention in this case? That’s a vital question.