GEM Financials - Turkish banks valuations

Implied cost of equity appears low

The market valuation of Turkish banks is currently implying a cost of equity of 12% on average, which we find too low. Turkish risks – inflation, regulatory and political –, as well as global outlook warrant more conservative risk assumptions and hence require higher rate of return. Inflation itself should increase towards 9% mark in 1Q16 to factor in further weakness in currency. Our models factor in an average 14% COE, some 200bp above that implied by the market.

Downside risk to earnings?

The street’s earnings estimates are too optimistic overstating ROEs and equity values. The consensus 2015 and 2016 ROE estimates, average 11% and 12%, respectively assume fairly bullish outlook concerning funding in particular. The analysts indeed expect moderation in swap costs, which we find unlikely. The industry NIM adjusted for cost of swaps, on our assumptions, turns out 40bp below where the consensus NIM is. An average 40bp cut in NIM would reduce 2016 earnings by an estimated 16% with all else remaining the same. 

Share prices to fall 20% before year-end to factor in downside risks

Turkish banks are currently trading at an average one-year-forward price to book equity multiple of 1.05x. We reckon share prices should fall at least 20% to accommodate the weaker outlook and increased risks reducing the industry price-to-book to below 0.85x mark. The upside risk to our case would be a FED surprise; if the FED decided not to hike the rates in December; Turkish banks would respond positively.