MENA & Turkey Financials

Ercan Uysal

Thematic (Sector/Industry)

A wide array of leading indicators suggests that the Turkish economy has started to contract sharply in 3Q18 largely due to a steep downturn in credit flows following a 35% YTD devaluation in TL against the USD, while the most recent economic data reveals that the slump in economic activity is gathering pace. Against this steep contraction in economic activity, the Turkish non-financial corporate sector is sitting on top of a mountain of debt, representing 73% of GDP (vs. EM median of 48%), half of which is fx-denominated. After having registered the second largest NFC debt build-up since 2009 after China, we are not surprised to see that the average net debt-to-equity of the BIST non-financial firms has risen to 0.60x of equity in 3Q18 (vs. EM average of 0.40x) from 0.2x in 2010, while the median interest coverage ratio (ICR) of the BIST non-financial firms declined to 0.8x in 3Q18 (vs. EM median of 3.5x) from 1.6x in 2014. Our top-down models suggest that EBITDA margins will likely collapse over the course of the recession, while financial expenses will continue to rise due to the higher cost of financing, leading to a sharp decline in corporate profits in 2018/2019.If our macro scenario holds true, the BIST non-financial stock prices should decline by about 30% in TL terms in the next 6 months from the current levels. The current sharp contraction in economic activity will likely force the government to loosen its monetary and fiscal policies before the March 2019 elections, which could cause inflation to stay at elevated levels, or even jump higher, in our view. This could, in turn, lead to further currency weakness and higher bond yields. Under such circumstances, we believe investors should avoid taking directional bets on the Turkish equities while taking advantage of relative plays.We recommend taking long/short positions based on the following criteria:<ol><li>LONG stocks with 1) strong balance sheet (i.e. low leverage), 2) defensive business model/high exports share, 3) long fx or relatively lower hedged short fx positions, 4) high ROE/ROI </li></ol><ol start="2"><li>SHORT stocks with 1) weak balance sheet (high leverage), 2) consumer discretionary and cyclical stocks (low exports), 3) high short fx positions, 4) low ROE/ROI </li></ol>Please note that some of these stocks might not have sufficient liquidity to short or might be very costly to short. In that case, we recommend buying our LONG basket and shorting BIST-100 futures against this basket as a proxy.

A wide array of leading indicators suggests that the Turkish economy has started to contract sharply in 3Q18 largely due to a steep downturn in credit flows following a 35% YTD devaluation in TL against the USD, while the most recent economic data reveals that the slump in economic activity is gathering pace. Against this steep contraction in economic activity, the Turkish non-financial corporate sector is sitting on top of a mountain of debt, representing 73% of GDP (vs. EM median of 48%), half of which is fx-denominated. After having registered the second largest NFC debt build-up since 2009 after China, we are not surprised to see that the average net debt-to-equity of the BIST non-financial firms has risen to 0.60x of equity in 3Q18 (vs. EM average of 0.40x) from 0.2x in 2010, while the median interest coverage ratio (ICR) of the BIST non-financial firms declined to 0.8x in 3Q18 (vs. EM median of 3.5x) from 1.6x in 2014. Our top-down models suggest that EBITDA margins will likely collapse over the course of the recession, while financial expenses will continue to rise due to the higher cost of financing, leading to a sharp decline in corporate profits in 2018/2019.If our macro scenario holds true, the BIST non-financial stock prices should decline by about 30% in TL terms in the next 6 months from the current levels. The current sharp contraction in economic activity will likely force the government to loosen its monetary and fiscal policies before the March 2019 elections, which could cause inflation to stay at elevated levels, or even jump higher, in our view. This could, in turn, lead to further currency weakness and higher bond yields. Under such circumstances, we believe investors should avoid taking directional bets on the Turkish equities while taking advantage of relative plays.We recommend taking long/short positions based on the following criteria:LONG stocks with 1) strong balance sheet (i.e. low leverage), 2) defensive business model/high exports share, 3) long fx or relatively lower hedged short fx positions, 4) high ROE/ROI SHORT stocks with 1) weak balance sheet (high leverage), 2) consumer discretionary and cyclical stocks (low exports), 3) high short fx positions, 4) low ROE/ROI Please note that some of these stocks might not have sufficient liquidity to short or might be very costly to short. In that case, we recommend buying our LONG basket and shorting BIST-100 futures against this basket as a proxy.

Turkish Non-Financials: This Is Not Your Ordinary Cycle