Turkish Banks: What Went Wrong?

Turkish banks which have spent years with high profits generated in the past, only managed a ROE of 10.6% (10-year average was 16.1%), well below the business’ cost of capital of at least 15% and the returns which investors aspire. Unlike their peers around the world, financial institutions in Turkey are not in a regulatory cycle either. We have mentioned recurrently the rising risks of earning recession in Turkish banks. Not surprisingly, today only two of the six major bank stocks trade with a premium to its book value in Istanbul. Additionally, in January 2016, systemwide ROE was up by only 6 bps to 10.7% from 10.64% and did not no improvement is in on the horizon.

Turkish Banks - Valuations

Below is the trend in ROE versus COE which is estimated with monthly average yield of 10-year Turkish government bonds, equity risk premium of 5.5% and 1.0x beta. Simply, banks’ earnings do not justify premium valuations since they are capable of adding economic value.

Turkish Banks - ROE v COE

We previously published sufficient number of articles mentioning the declining profits in banks, and now think it is better to look beyond the metrics and try to analyze what actually went wrong and what are the underlying factors that drove earnings downside.

Turkish Banks - Summary Financials - 2015-2005

Above is a financial summary of Turkish banking universe for the last ten years. 2010 was the year when the industry started to experience ROE deterioration, the same period when Turkish central bank lowered interest rates to historic low levels in order to support the recovery process following the global financial crisis. Remember that Turkey was the second fastest growing major economy in the world after China in 2010-11 when the country recorded high single-digit digit real GDP growth rates. The strategy paid out well in the short-term, however, caused concerns around overheating thereafter. Turning back to the banks’ financial performance, NII posted for those two fiscal years in the industry was even lower than that for 2009. Banks seemed to struggle to price the loans desirably in a low interest rate environment. But more importantly, they needed new funding sources to finance the lending growth as keeping cash deposited in a bank was less attractive. That was the time the industry began to issue bonds and it had a new line on the interest expenses side. Interestingly, Turkish banks did not fully benefit from the zero-interest policy rates implied in developing economies until the very first phase of extreme money printing known as quantitative easing. Borrowing costs had remained relatively high until the liquidity injections of the Federal Reserve were in progress.

Banks enjoyed the QEs effect until mid-2013, when the Fed Governor Bernanke signaled a downshifting of his printing press. That meant a massive sell-out in emerging markets, and Turkey had environmentalist uprising to boot (Murphy’s Law). Then, the second source of profit erosion showed itself, the melting down in local currency. Banks recorded a loss of TRY7.1 billion due to the volatility in foreign exchange rates in 2013. That being said, they also were obliged to borrow via the repurchase agreements this time since the capital started to flow out of emerging markets this time. In a recent post, we shared our views on the funding challenges of the banks with warnings about the Turkish central bank doubling its overnight lending. This type of funding is also not cheap needless to say, and ultimately putting pressure on the bottom-line across the board.

Interestingly, banks have failed to grow their fees from loans over the past two years which led weaker revenues. During the same period, total non-interest income increased by 12% which was below the long-term growth rate of 15%. This has been partly due to the new regulations that have restricted fees.

A simple analysis of trends in income statement presents the key findings to walk through as to what actually went wrong. On the other hand, having investigated the sector-level balances, a bigger picture is easily seen. “…And then like a lot of dreams, there’s a monster at the end of it.” After a quote from a beloved TV series, let us present the crucial point at the end. The real trouble with Turkish banks is the leveraging ending up with lower gains, in other words, taking more risks for earning less, which is also an ominous data point for the economy in general. “Cautiously lowering our guidance” is the kind of a key phrase you might hear in earnings calls this year.

Migros: New Growth Strategy Will Pan Out

Migros (BIST:MGROS) has recently underperformed the broad market despite the retailers specifically showed recently during the same timeframe. On a ytd basis, the shares fell by more than 12% while gains in the Turkish equity market benchmark index BIST 100 exceeded 5%. The underperformance is mostly due to the short FX position risks and the fears that the company would post a loss higher than expectations.


While accepting that Migros does face a number of challenges in the near-term, there is good chance that it could be the turnaround story in Turkish retail sector. Back in 2011 the company adopted a new growth strategy which is based on small sized convenience-stores. This strategy will pan out well as small sized stores have broadly outperformed traditional ones on sales by generating a higher sales density, since Turkish consumers visit stores frequently resulting in smaller basket sizes. As a result of this have seen the number of new store openings increasing in the recent years (the annual average 150 since 2001 versus 70 before 2011) while average store area decreasing (to 600m2 from 1000m2). The majority of the new stores are in the form of discount markets (branded as M-Jet) as might be guessed.

Migros is to face heavy competition from other discount stores such BİM (BIST:BIMAS). BIM is still perceived as the cheapest retailer according to the consumer surveys. However, we have seen the price differential between Migros and BİM coming down below 20% from above 40% in four years. Migros have introduced a line of private label items in order to lower the average price index. Basket size growth in Migros would be somehow slower than annual inflation rate this year, however, this would be offset by a higher traffic growth. Thus, we believe Migros will hit double-digit sales growth amid an expansion phase. Note that Migros is operating with a relatively higher EBITDA margin (+6%) versus BİM (below 5%).

Migros has successfully managed to improve its operating efficiency with higher sales to number of employee figures. I believe there is still room in Migros for further improvement. That being said, Migros also may be considered as a mean and lean company when compared to BİM regarding the number of employees per 100m2 of sales area (2 versus 2.4). With the minimum wages raised by 30% as pledged by the government, efficiency has gained importance for retailers, as a significant part of the employees in retailers are minimum wage workers. At this point Migros has an advantage over its peers.

At the end of 2014, the company carried a €835 million of financial loans in its balance sheet. Restricting euro-denominated debt has remained as the key challenge for the company in 2015. This also has built a supportive case for bearish views on the stock. Further deprecation of the lira against the euro for sure will have an impact on the bottom line through higher financial expenses. Nevertheless, risks related to this, in my view, are overblown. The company is expected to experience a total cash outflow of approximately €650 million over the next seven years, that would generate TRY280 million of financial expenses per annum with the assumption of 5% currency depreciation each year. Given the current valuations against its peers, this appears to be already priced in.


The following is our DCF analysis for Migros. Our estimated revenues figures below are based on 7% basket size growth, 1.75% traffic growth, and 3% sales are growth, averagely, over the course of next three years. Our terminal value includes a long-term growth rate of 5%. We discounted the free cash flow for the next ten years with an average WACC of 14.9% which is derived from a risk-free rate of 9.5% (2-year average of 10y Treasury bond yields), equity risks premium of 5.5% and an unlevered beta of 0.9x (for EMEA retailers). Our analysis offers a fair value of TRY19.5 which implies 27% upside from the current stock price. Ultimately, with its turnaround story, limited risks and potential to the upside, Migros is a “buy on dips” kind of play.




Migros acquired 95.5% of Tesco’s Turkish subsidiary Kipa’s shares for 302.3 million liras ($134 million). Tesco-Kipa operates through 49 hypermarkets, 31 shopping centers, 120 supermarkets and 3 gas stations. By paying roughly 0.1 P/BV for the acquisition, Migros manages to increase its total sales are by more than one third. As Tesco has faced significant challenges recently, the deal is considered as dirt cheap, however, a buy at the rock bottom price for Migros which also help the company to pull out even better financial performance in the upcoming period.

With the help of bullish emerging market sentiment, Migros shares reached our target price of TRY19.50 in only 32 trading days on 4/13/2016, outperformed the benchmark equity index BIST 100 by 14%. Total return was 31% in USD terms. We recommend investors holding the stock to be more cautious as the recent rally in Turkish stocks is likely to slow amid high valuations.

More information about the stock performance since recommendation is given at the table which will be periodically updated.

For more investment tips and ideas in Turkish stock market, send an e-mail to oguz (at) turkishmarketnews (dot) com.

Turkish Banks: 4Q 2015 Earnings Preview

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.

Turkish Banks vs MENA Peers

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.