Halkbank: Not A Good Play for the Current Trends

Halkbank has performed poorly since last November and now the stock trades slightly below its book value and is one of the worst performing stocks among Turkish blue-chip stocks.

Halkbank - Stock Price

The bank closed 2011 with 14.4% return on equity and an aggregate net income of 2,206 million liras, which was 22% lower compared to the posted number a year earlier. Net interest margin stood at 4.2% at yearend thanks to solid fourth quarter margin of 4.5%. The bank saw its loan portfolio growing 19.9% on yearly basis. Loans to deposits ratio rose to a record level of 98.1% as deposits grew moderately by 2.9% year-over-year. Not surprisingly, the reported capital adequacy decreased to 13.6% thanks to the rise in risk-weighted assets arising out of the wildly growing loan portfolio.

Halkbank - Valuations

The worrisome point is that the return on equity figures have been on steady decline in Turkish banks, but more remarkably in Halkbank. For the last four quarters the bank has been posting a figure below 20%. Following that the stock has been interestingly most volatile one among large-cap Turkish banks stocks that deteriorates the outlook of the stock through its impact on beta which is a component of the cost of equity.

Turkish banks reported the highest 12-month trailing net income ever in February with remarkably rising fee income. Given its lower exposure to credit cards compared to those of its peers, Halkbank operates with lower fee income generation. Thus, I believe Halkbank is not fully benefiting from the improving sector outlook.

Halkbank - Price Target

My price target for the stock is 14 TRY implying a not convincing upside potential of 9%. I arrived at this price target based on 1.1x price to book multiple, 9% assumed growth rate, and 15% cost of equity which is derived from a beta of 1.4x, an equity risk premium of 6%, and a risk-free rate of 7.5%.

Valuation

Of the 36 analysts covering the bank, 23 have a buy ratings, while 11 recommend to hold and 2 think the stock should be sold, according to the company’s Investor Relations website.

Finally, do not forget to read our disclaimer.

Determinants of Bank Profitability

Examining the determinants of the banks profitability is very important in any economy as these foundations perform key financial functions. In Turkey it is even more important considering the fact that the stock market is heavily dominated by the banks. See here, here and here for more about the bank-intensive style of Turkish financial markets.

Lately we noted that on historical basis profitability indicator ratios of Turkish banks have been dramatically declining despite the relatively high valuations. We observed those bank stocks losing momentum and the benchmark equity index evaporation right after, a harbinger for what might happen remainder of the year.

At this stage we find it important to find out what the industry-specific and macroeconomic determinants of Turkish banks’ profitability are because of its strong impact on the characteristics of stock market. To be more accurate I narrow the scope of this research and used the data of the commercial banks only -which is compiled by Turkish Banking Watchdog (BRSA)-.

Below is a list of possible determinants of Turkish commercial banks’ profitability.

  • Total Assets (log)
  • Capital Adequacy Standard Ratio
  • Loans to Assets
  • Non-performing Loans Ratio
  • Liquid asset to assets
  • Deposit to Assets
  • Loan to Deposit
  • Net Interest Margin
  • Non-interest Income
  • Annual Real GDP Growth
  • Annual Inflation
  • Real Interest Rates

After collecting the data over the time period between 2003 and 2014 I calculate the correlation between the variables listed above which is as follows:

Turkey - Determinants of Banks Profitability - Table 1

As a profitability measure again we use the return on equity (RoE) ratio. Following that, this next table demonstrates the relationship between the profitability of Turkish commercial banks and the given independent variables through a regression analysis.

Turkey - Determinants of Banks Profitability - Table 2

The results suggest that the relationship between the banks’ profitability and the selected macroeconomic variables is significantly weak. On the other hand we find out that the banks can improve their profitability through increasing their capital adequacy and decreasing their loan/asset or loans/deposit ratio. Our main deduction from the latter finding is that to improve their profitability the commercial banks in the country need pay more attention to being well-capitalized and having a more liquid financial position with lower loan/deposit ratio.

For the issue of declining capital adequacy ratios in Turkish banks read this.

and this is for the increasing risks around loan/deposit spreads.

Considering the above-mentioned developments it would not be surprising to see banks posting lower income figures in the upcoming quarters.

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.

Turkish Bank Equities Historical Valuations - 5 Years

Turkish Bank Equities Historical Valuations - 3 Years

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.

Turkish Banks Equities Return on Equity Figures

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.