Is Yatirim Menkul Degerler — Update 19 September 2016

Established in 1996, Is Yatirim Menkul Degerler (ISY) is part of the Isbank group which is the largest private bank in Turkey; with its affiliates, it owns just over 70% of ISY shares. ISY benefits from Isbank’s distribution network and standing among the Turkish business community. ISY’s core investment banking division has leading market shares in many aspects of investment banking in Turkey. It is also active in equity IPOs, bond issue, asset management, non-performing loan management and private equity.

The background for Turkish financial markets has been challenging, with political uncertainty including a coup attempt (mid-July) and the presence of regional risks, including troubled neighbours Syria and Iraq. While these have been unhelpful influences for the economy there was positive news at the end of June when Russia announced the progressive removal of its sanctions (following the shooting down of a Russian military jet by Turkish forces in November 2015). In the circumstances, Turkey’s Borsa Istanbul 100 index (BIST 100) has been surprisingly resilient; it is up nearly 9% year to date and down less than 6% since the coup attempt (Exhibit 1).

Similarly, the exchange rate (Exhibit 3) has displayed relative stability and the two-year government bond yield (Exhibit 4) has fallen since the beginning of the year despite a spike up following the attempted coup.

While central bank measures to ease liquidity and support the economy have played a role, these market indicators can also be seen as demonstrating a degree of confidence in the longer-term prospects for the economy and market despite continuing challenges.

In terms of the economy it is worth recalling that Turkey recorded compound annual growth of 3.8% between 2006 and 2015 compared with 1.1% for G7 economies, while prospectively the IMF has been looking for GDP growth of approximately 3.5% for the years to 2021. Near-term estimates may be trimmed, but longer-term growth expectations seem likely to be broadly maintained.

Next we look at trading and issuance activity levels. Exhibit 5 shows the evolution of daily values traded on the equity and derivative markets. While both have shown considerable variation, levels have increased over the period shown; equity trading is marginally ahead and derivative trading is up 7% in the first eight months of this year compared with the same period last year.

The final two charts in this section show the level of equity and debt issuance since 2006 and 2010 respectively. Equity issuance has been trending down in recent years with increasing economic and political uncertainty following a post-crisis surge. In contrast, there has been no slackening in the growth in debt issues with the run rate year to date ahead of the same period in 2015.

Looking ahead, a period of greater political stability and a normalisation of conditions in the wake of the coup attempt would create more favourable conditions for foreign investment and longer-term economic growth. This would in turn potentially provide an increasingly favourable background for ISY’s investment banking activities.

We start with the performance data by market area for IS Investment (Exhibit 8); here, the largest percentage change between H115 and H116 was in the volume of foreign exchange (FX) margin trading where strong market growth was magnified by an increase in IS Investment’s market share from 6.2% to 7.2%. Within primary issuance, debt securities issuance was up 23% and IS Investment retains a leading market share, also at 23%. The number of M&A deals completed remained muted at five versus four last year, reflecting a difficult economic background. While the level of lending for equity margin trading declined 15%, the company reports that profitability here improved. Finally, in asset management overall assets under management (AUM) increased 17% including a particularly strong increase in pension funds (+35%).

An analysis of revenues is shown in Exhibit 9. Commission revenues were notably strong (+31% YoY), while there was a decline in interest and trading income. Within commission revenues brokerage saw an increase of over 40% including marked strength in derivative, equity and FX commissions. Corporate finance also showed robust growth with M&A reported as a good contributor despite the still small number of transactions completed, as noted above. Overall revenues increased by 5.5%.

Costs increased by nearly 17%, with volume-related costs, higher exchange transaction fees and costs denominated in foreign currencies all contributing to the increase. As a result, the cost income ratio increased from 73% to 81%.

In Exhibit 11 we show the contribution to net profit by segment, summing to consolidated net profits of TRY26.2m, up 13% on H115.

The main business, IS Investment, recorded a 40% increase in net profit from the same period last year and achieved an ROE of 12.5% (group ROE was 8.0% compared with 10.1%). This result would have been significantly higher without a TRY17m corporate bond write-off. IS Private Equity saw an increase in the net loss as a result of weak results from its investee companies (which are consolidated by ISY), reflecting the tough trading background and the fact that these companies are mainly in the investment phase. IS Asset Management’s profit increased by 23%. At Efes NPL Asset Management there has been a pause in collections pending the outcome of court proceedings: once resolved, the result for this business is expected to improve. The elimination items largely relate to the investment trust and asset management businesses.

We show the changes in our estimates below reflecting the performance in the first half together with updated assumptions. These include the company’s expectation of continued improvement in Asset Management profitability and a higher estimated loss for IS Private Equity than previously. An increase in the expected minority loss within our estimates (increasing equity shareholders’ earnings all else equal) contributes to a greater attributable profit and EPS increase than we had estimated previously.

While there are no directly comparable quoted investment banks given ISY’s business and geographical profile, we put the company in the context of a group of European banks that have significant investment banking businesses (Exhibit 13). ISY has a considerably higher yield, trades on much lower P/E, and on a comparable P/B multiple despite earning a much higher ROE (c 10% on our estimates). This suggests ISY is relatively undervalued, although currency risk should be borne in mind.

We can examine this comparison further by using a rearranged ROE/COE model to calculate an estimate of the risk premium investors ascribe to ISY, assuming a ROE of approximately 10% and growth of 5%. This gives a COE of 12.7% for ISY, versus 6.7% for the European banks on average (using a 4% growth assumption). While the ISY COE derived in this way appears relatively high, it is consistent with the market level of the Turkish 10-year government bond (9.76%), a calculation of the equity risk premium for Turkey (6.8%) and the beta for ISY of 0.48 (both from Bloomberg). This suggests the current share price is close to a central valuation based on a ROE/COE model. However, we note the sensitivity of the valuation to changing assumptions for the ROE, growth rate or risk free rate. Positive moves could arise from internal measures at ISY or an improvement in the economic environment prompting a higher sustainable ROE input: increasing the ROE assumption to 11%, for example, would give a warranted price to book multiple of 0.75 and an indicated value 19% above the current share price (TRY1.23).