Price to Book Value – Turkish Market News

State-Owned Banks under Pressure

Considering the fact that poor performance from main bank stocks is more able to drag the whole market down in Turkey than anywhere else, I have been trying to provide comprehensive information about the key themes in the industry in order to measure the changing dynamics. From this point I find analyzing of state-owned banks’ recent performance extremely necessary as it is already seen as the biggest threat to Turkish markets.

Halkbank and Vakifbank are the state-owned banks whose shares also traded in Borsa Istanbul with free-float rates of 49% and 25%, respectively. Their poor performance compared to the peers on a year-to-date basis had been already eye-catching, but, it has been even clearer following the general elections which ended up with no single party majority. As being run by the state share prices of both banks were amenable to the outcome of the elections.

Above is the visualized form of year-over-year stock performances of Tier-1 banks in Turkey where two state-owned banks’ are shown in different shades of red. Vakifbank and Halkbank along with Yapi Kredi seem to be underperformers and all three have provided a negative return to investor through this period. Reviewing the stock performance with the fundamental data is here to be a key to fully discover the pricing dynamics and what actually lies behind.

According to 1Q15 results Halkbank posted a ROE figure of 15.7% that made it one of the most profitable banks in CEEMEA region, however, this could not have prevented the stock from trading below its book value. On the other hand Vakifbank with a ROE of 13.6% is traded a significant discount of 26% to its book value. In light of this information two stocks are not fairly valued, offer a huge potential upside, and each indeed would be a great buying opportunity for investors who are eager to take hard to predict political risks.

In a previous note about Halkbank, I mentioned that the stock should not have been the conviction call among Tier-1 Turkish banks, and it was not likely benefit from the current trends in the industry. The current valuation is definitely beyond the framework I had proposed. As a matter of fact it is safe to say that political worries could be overblown.

On the other hand, there is evidence that shows Halkbank has always been valued with a company specific risk premium. The following charts show that the bank is traded with modest multipliers when compared to Tier-1 banks. Moreover, now Halk is not exceptionally far from historical averages in valuation terms.

With so many upside and downside catalysts it is tough to allocate funds perfectly in emerging markets as the transformation in global monetary policy is likely to a game changer. Most particularly in Turkey it is crucially important to walk on eggs where the stock market is set to navigate in choppy waters. Within this context I believe the short term potential and longer term risks in Turkey’s state-owned banks stocks should be realized.

A Historical Analysis of Turkish Bank Stocks

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.

Turkish Banks: Expectations, Valuations & Risks

Expectations

Over the past two months we have seen earnings upgrades coming to an end in most emerging market as well as in Turkey. Specifically, for Turkish banks, consensus lowered next year’s earnings estimate by a considerable 0.7%, bringing the cumulative cut to 1.5% since mid-August. Still, analysts averagely estimate an earnings per share growth of 20% in 2015 following a 9% contracting this year. On the other hand projections at year beginnings proved to be optimistic in six of last seven years as we have seen those projections being downgraded afterwards.

Meanwhile, year to date return of Turkish banks stocks is 23.5% which higher than the return of the benchmark index XU100.

Valuations

Out of Turkey six large banks listed on the stock exchange, Garanti is the one enjoying premium valuations with P/E of 13.6 and with trading 1.5 times its book value. Akbank seems to have the second highest multiples. Yapi Kredi‘s lower P/E is due to selling its insurance subsidy to Allianz on a $1 billion deal. Compared to their peers, Isbank, Halkbank and Vakifbank are notably undervalued. Additionally, the six banks mentioned here account for 25% of market cap of the all companies listed on Borsa Istanbul.

Risks

Apart from the key risks including declining GDP growth projections, vulnerability of Turkish lira, and geopolitical risks, there may be some other industry-specific headwinds to face. First, the loan to deposit ratio in Turkish banks have stayed above normal since 2012 which is now 115% leaving the companies with in sufficient liquidity to cover any unexpected fund requirements. Second, Tier1 common capital ratios (Capital Adequacy Standard Ratios) which measures the financial strength of banks by comparing the banks’ core equity capital to their risk weighted assets, have appeared to be weakening since the late-2008 global financial crisis (the following link goes to the article where we mentioned the importance of the sound fundamentals of its financial system for Turkey).