One of the key market themes that marked this year has been the bank stocks trading with low multiples and the advancement in the industrials. Time and time again we uttered that the golden age of Turkish banking is over (see here and here) which was finally embraced by a top banker in Turkey. Given the banks capturing a dominant share of the Turkish stock market the BIST 100 index has expectedly performed poorly.
We also have seen the ratio of the Turkish banking index (BIST:XBANK) to industrials index (BIST:XUSIN) falling below 2 this year which may have seemed like an anomaly from a historical perspective. A part of analysts attributed this to the start of a bear market while the other part mentioned a changing overall market trend. Despite the fact that I have been long-term bear and clearly recommended investors to avoid from risky Turkish assets (and EM in general), I also believe the upheaval in Turkish market has begun forcing investor to be extremely selective to be able to make a winning pick.
Interestingly, according to volume data the dominance of the banks are likely to continue. This may require the fund managers moving to a set of unconventional investment strategies such as smart-beta from typical index investing as hoping and holding bank stocks leave investors face a potential long-term bear market.
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.
Once upon a time, there was a world of infinite liquidity. An old man with beard always lend his hands helping hands in order to keep the bewitching music going on and warms the cockles of all hearts. What a tale to make connection with the real world, nevertheless, I have to face that I need to work hard to be as good as Hans Christian Andersen.
Turning back to boring financial markets after a fairy FOMC preview, we firstly need to say that Turkish equities may still have more potential upside. Let’s take a look at the chart below comparing the Turkish equities index with MSCI emerging markets index.
This chart demonstrates that Turkish equities have been oversold through the last six month, due to deteriorating macro indicators and high politic risk arising out of Gezi Park protests and Syrian conflict, but Turkey might close the gap within weeks.
One more indicator showing that Turkish equities are cheap, is the P/E ratios. Here’s a list of P/Es of some markets below (our source is Bloomberg here):
- New Zealand Exchange 50 Gross Index: 18,29
- Korea Stock Exhange KOSPI Index: 12,92
- India’s BSE SENSEX Index: 18,27
- JSE Africa Top40 Tradeable Index: 21,52
- Russia’s MICEX Index: 5,20
- Borsa Istanbul National 100 Index: 10,80
- Ibovespa Brasil Stock Exchange Index: 7,90
- iShares MSCI Emerging Markets: 12,00
Using these multiples, Turkish stocks are slightly cheap to buy now. Particularly, a trade-in is highly possible between South African assets and Turkish assets if we consider time-zones (in other words, there assets are traded at the same time).