Jacob Grapengiesser of East Capital -
With the arrest of senior members of the Turkish armed forces in March, investors in Turkey have become concerned again about the rising political noise in the country. While I think this is certainly a matter to keep an eye on, Turkey has proved to be a place where this issue is always present, so I wouldn't say it's much worse this time around than it has been in previous years.
This year there will undoubtedly be news flow on the political situation, with early elections clearly one of the risks. But early elections would most likely not happen within 2010. Rather, the issue I believe that is key to the Turkish market in 2010 is whether the country's banks can repeat the fantastic year they enjoyed in 2009. The banks recorded huge profit growth of 50-60% in 2009 because of the rapidly falling interest rate environment. This caused their margins to expand over a three- to nine-month period, since their loans have longer maturities than their deposits, plus it helped give their trading gains a boost.
What investors are now asking themselves is whether this profit growth is sustainable or was a one-off?
The banks are saying that while that level of profit growth might be a one-off, many predict they will still grow their earnings in 2010, which would be a remarkable performance given that after such as a fantastic year, you would expect a year of consolidation or even contraction in profits.
The banks are now entering a new interest rate environment where mortgage loans to Europe's fastest-growing population become feasible in Turkish lira just because of the low nominal interest rates. Where previously investors had bought Turkish banks because of their positions in government bonds and how they thought those government bonds would perform, now they will invest based on how the real banking business will develop. Lending is currently growing 15-20% per year, and going forward I can see this growth even higher at 20-25% over the next three to five years. With banks trading at a price/earnings (PE) ratio of below 10x expected earnings for this year, this represents quite an opportunity.
The outlook for the industrial sector is a bit more mixed, but with banks making up about half the Turkish index, if they do well, the market does well.
Another potential plus for Turkey could be convincing the global investor, rather than the dedicated Turkey investors like East Capital, to return to the region and Turkey. The Turkish market performed well last year, but it would benefit more if international investors came into Turkey. Looking at the investment flows into emerging markets, Central and Eastern Europe received only a third of what it should've received in 2009 based on the share of Europe, the Middle East and Africa (EMEA) in the emerging market indices. Instead, emerging market investors concentrated on putting money into Asia and Latin America. But in December and January, there were signs of these flows reversing back into CEE, especially from Latin American which has become expensive. Both Turkey and Russia are cheap markets from a fundamental point of view.
Turkey's fantastic performance in 2009 was down to some extraordinary factors. Rather than a repeat of last's quick gains, this year will be part of a longer-term story, which might play out in 2010 but might also play out in 2012 - when exactly is difficult to tell.
So to summarise, here's my four key points for 2010:
1) The political situation is not as bad as it's being portrayed in the international press;
2) Large-cap stocks trading under a PE of 10x with excellent potential over the next five years;
3) Some inflows into Turkey from other emerging market regions;
4) A new interest rate environment that is changing the rates at which banks can lend. Usually markets can revalue when you have that situation.
Jacob Grapengiesser is a partner of East Capital
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