Is Yatirim Menkul Degerler — Increasing estimates again

Is Yatirim Menkul Degerler (Is Yatirim or ISY) is a leading Turkey-based brokerage group established by Turkiye Is Bankasi Yatirim Menkul Degerler (İşbank), which is Turkey’s largest private bank by assets. İşbank and its affiliates own c 72% of Is Yatirim’s shares. ISY’s core is its investment banking division, which commands leading high market shares in many areas of investment banking in Turkey, including equity and derivatives trading and debt securities issuance. Through its subsidiaries, ISY is also active in asset management, non-performing loan management and private equity.

Following the turbulent political climate of 2016 and with the result of April’s constitutional referendum settled, the BIST 100 index, the main Turkish equity index, has continued to climb (Exhibit 1). With relative stability returning to the FX markets, the gains year to date are broadly similar in both Turkish lira and US dollars. Interest rates are being held at high levels until there are signs of an improvement in inflation and two-year bond yields have recently increased towards year-high levels once again. Positively, the annual CPI rate moderated in July to 9.8% compared with a monthly average of 10.9% during the first six months of the year.

A number of forecasters have recently lifted their growth expectations for Turkey in 2017, although there are quite wide differences in forecasts. GDP growth rebounded to 5.0% in Q1, supported by government incentives to stimulate the economy (tax holidays, credit guarantee fund), as well as improved exports and domestic consumption, and there are indicators that this growth continued through Q2. Fitch has upgraded its 2017 GDP growth forecast to 4.7% from 2.3%, although the IMF has maintained its 3.6% growth expectation while noting Turkey’s improved export performance.

ISY produced a very strong set of results in H117, with revenue growth driven by a significant increase in interest and trading income, while costs have been kept under tight control. In this section we examine operational performance in each area, summarised in Exhibit 3, before looking at segmental revenues, costs and profits. The key highlights in H117 were:

The H117 non-consolidated result for Is Investment was driven by underlying earnings, with a broadly similar contribution from subsidiary dividend payments year-on-year. These are contained in the eliminations line of Exhibit 3, with the significant decline in the elimination adjustment between Q217 and Q117 reflecting the usual seasonal timing of payments. The Is Investment solo performance, adjusted for the loss generated by its foreign subsidiaries and the internal group dividends received from subsidiaries and other eliminations, represents almost the entire group consolidated net adjusted profit. In aggregate, the H117 subsidiary contribution was TRY0.5m, a marked improvement on the TRY2.6m loss recorded in H116.

In Exhibit 4 we show a summary of the key operational performance metrics for the group.

ISY has performed very strongly in derivatives trading in H117. Q1 saw an exceptional increase of 110% in ISY’s traded volume (TYR59.3bn) and Q2 (TRY51.8bn) was another excellent quarter. For H117 as a whole, ISY trading volume is up 79% y-o-y compared with 24% growth in the overall market, increasing ISY’s market share by 4.5pp to 14.7%, more than 2pp ahead of its nearest competitor. ISY’s equity market trading performance has also been strong with H117 volume growing 19% y-o-y compared with 15% growth for the market. ISY is number two in the market rankings by volume with a share of 8.1%. As well as benefiting from higher volumes, we understand that ISY has been able to widen its commission margins slightly, partially compensating for increased exchange costs, after two years of margin pressure.

In market debt securities issuance ISY intermediated 66 issues in H117 with a volume of TRY10.8bn. In debt public offerings ISY leads the market with a very high market share and has grown H117 volume by c 9% y-o-y to TRY4.7bn, while overall market public offerings volumes have declined by around one-third to TRY8.8bn. The overall debt securities issuance market is currently being driven by a strong growth in private placement activity, which grew by 58% to TRY48.1bn. Private placement activity is dominated by the large banks and although ISY saw growth in this area (c 5% to TRY6.1bn) and retained its leadership position in debt issuance overall, its market share has slipped to 19% compared with 23% in H116. The size of the equity margin trading business increased slightly in Q217 compared with Q117, with a loan size of TRY277m vs TRY262m. Although the y-o-y decline is 4%, this may indicate that the steady decline from a high of TRY433m at the end of FY15 is at or near an end. ISY has maintained a strong market share of c 22% (FY15 high of 29%) and indicates that it has been able to increase its interest rates on equity margin. In other capital markets activity ISY participated in two M&A transactions in Q217, bringing the total to three ytd. Management expects to complete two further M&A deals before year-end and is also working on a potential IPO.

The Turkish pension and mutual funds markets continue to grow in size, up 27% and 13% y-o-y in H117 to TRY69.6bn and TRY46.6bn respectively. ISY grew market share in pension funds with its AUM increasing by 30% y-o-y, although 9% mutual fund growth slightly trailed the market. The mix shift from mutual fund assets to pension assets should be a positive for the average fee margin. Other AUM includes private assets, alternative investments and assets managed for IS Investment Trust. These grew by 54% to TRY5.7bn.

Turning to revenues, growth interest and trading revenues (+60%) were the main driver of the 39% increase in total operating revenues. Commission revenue growth of 16% was also healthy and includes, within brokerage, a contribution from FX margin trading volumes. Although up 12% y-o-y in H117, the decline in brokerage revenues from Q117 to Q217 reflects weaker FX revenues as a result of the introduction of new regulations in February 2017 that have capped leverage levels and reduced investor appetite in this area. Corporate finance and asset management revenues showed strong growth.

Costs have been well maintained and have increased considerably less than revenues, despite a greater sales and marketing spend. Total costs grew 5% y-o-y in H117 and were lower than the TRY185.6m recorded in H216. Costs tend to be seasonally higher in H2. The monthly average level of Turkish CPI was 10.9% during H117. As a result of the positive gap between revenue and cost growth, the operating margin reached 39% in H117 compared with 19% in H116 and was a very high 44% in Q217.

At the net profit level, the factors detailed above explain the sharp increase in profit performance at Is Investment and the (70%-owned) asset management subsidiary (net attributable profit +37% to TRY7.1m). Is Investment Trust (28.9%-owned) saw a 39% increase in H117 contribution compared with H116 and Q217 improved on Q117. The result mainly reflects mark-to-market movements in the assets of the Investment Trust, which are substantially comprised of fixed-income investments (c 62% at the end of 2016) as well as cash, equities and other investments.

Accounting rules mean that Is Investment consolidates the investee companies of (29.1%-owned) Is Private Equity. The continuing losses that it reports for the subsidiary therefore reflect its share of the trading performance of these investee companies, predominantly consumer-facing businesses in a difficult market, and the administrative costs of the private equity subsidiary itself.

The turbulence experienced in the Turkish economy over the past 18 months has inhibited (74%-owned) Efes NPL’s ability to collect loans and interest, leading to losses. In Q217 there are signs of improvement, with the loss narrowing to TRY1.2m from TRY3.9m in Q1. For H117 as a whole, the loss is reduced by 11% to TRY5.1m.

The strong year to date result from the core investment banking operations of Is Investment leads us to materially increase our FY17 estimates, although we have made only minimal changes to FY18. Our dividend forecast for both years increase materially, as discussed below. The changes to our net attributable profit estimates by division are shown in Exhibit 7.

For Is Investment we have increased the FY17 revenue forecast from TRY361.4m to TRY378.3m or TRY180.0m in H217 compared with TRY198.3m in H117. Although we assume what we would consider to be a more normal cost-income ratio of 77.5% in H217, an increase from the 54.7% reported in H117, the forecast full-year ratio drops from 75.0% to 65.5%. Given the lack of visibility in global markets activity we have made no material change to FY18.

In FY17 the increased Is Investment forecast is only partially offset by reduced estimates for Is PE and Is Asset Management. Although Is Asset Management continues to show good levels of AUM growth, we feel that the improvement in operating margin previously implied by our forecasts may be difficult to achieve.

Exhibit 8 summarises the key changes to our forecasts on a group basis, a striking feature of which is the increases that we have made to forecast DPS for both this year and next. With relatively little need for capital retention, the company has a policy of paying out a high proportion of distributable earnings, which are themselves a high proportion of reported earnings. For FY16, ISY distributed 91% of distributable earnings (three-year average 88%), which is equivalent to an 84% payout of reported net earnings/EPS (three-year average 82%). Given the more settled tone to markets in Turkey, we now assume that FY17 and FY18 distributions will follow a similar pattern with a c 81% payout of reported earnings in both years.

In the absence of other investment banks with the same geographic and business profile, we continue to benchmark our valuation of ISY with that of a basket of European banks, which each have substantial investment banking operations. Although the year-long strong rise in ISY’s share price has continued since publication of the H117 results, ISY continues to have the lowest P/E despite having the highest forecast yield and prospective returns on equity and assets. In terms of price to book value (P/BV), the shares now command a premium to the average of the group.

We use our ROE/COE model to deduce the implied cost of equity that investors appear to be applying to ISY and to the wider group. Looking first at the wider group of peers, by assuming a long-term growth rate of 4% and an estimated ROE of 7% for the peers, we derive an implied COE of 7.9%, a similar level to our last note in May 2017. Performing the same calculation for ISY but using an assumed long-term growth rate of 5% and an ROE of 13% (slightly below our estimate for FY18), we derive an implicit COE of 13.4%, down from 15.4% in May 2017, still well above the peer average but now very slightly below the 13.8% COE calculated by Bloomberg.

An alternative way to consider the current valuation of ISY is to look at the c 1.0x current P/BV ratio, implying that the market expects the ROE to at least match the COE. Using the Bloomberg estimated COE of 13.8% and 5% long-term growth suggests the market is anticipating a 14.0% ROE. We note that this is similar to the 13.8% that we tentatively forecast for FY18 and is noticeably below the 16.5% that we expect for FY17.