Is Yatirim Menkul Degerler — Update 29 November 2016

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

It has been a turbulent year for Turkish stocks, in large part due to the political situation in Turkey and its neighbours, with an attempted coup in July and war in Syria and Iraq. Despite these and other factors, the BIST 100 index has been remarkably resilient, up 7.9% in Turkish lira terms over the year to date and having recovered since the coup attempt to the levels of May and June. In part this has been due to the cessation of Russian sanctions in June, which had been imposed after a Russian military plane was shot down by Turkish forces in November 2015.

The Turkish lira has also been affected by political developments and has fallen 15% against the US$ over 2016 (Exhibit 3). Two-year Turkish government bond yields have been rising since the beginning of October, reversing a downwards trend which persisted for much of the year (Exhibit 4).

While developments in government bond yields partly reflect the political and economic situation in Turkey and a downgrade by one ratings agency, other factors are also at play: notably, the rise in US government bond yields following the presidential election, which has depressed emerging market currencies and asset prices.

Trading and issue activity levels in Turkey have shown volatility for similar reasons to the indicators mentioned above. Exhibit 5 shows the daily value of equities and derivatives traded at the Borsa Istanbul since 2013. The trend is broadly upwards and the declines in Q316 have been reversed, with both now above their levels at the end of 2015 (by 2% and 3% respectively).

While new equity issues have declined in recent years, with three so far in 2016 and six in 2015, down from a post-crisis peak of 27 in 2011, debt issue has risen significantly, with over 500 issues in 2016 to date, against fewer than 100 in 2011.

Looking in particular at the BIST 100 index, the equity market appears to have welcomed the return and consolidation of political stability since the attempted coup. More stable government and better relations with both Russia and the EU may allow the momentum of economic reform to gather pace, and encourage both foreign and domestic investment. The IMF forecasts that the Turkish economy will grow at around 3.3% pa from 2017 to 2021, compared with a forecast of circa 1.5% pa for G7 economies. This suggests an encouraging outlook for the business and economic climate in which ISY operates.

In this section we discuss ISY’s performance in each market area first before analysing revenues, costs and profit. The biggest year-on-year change was the growth in equities trading: ISY’s market share rose from 7.1% to 7.8% (Exhibit 6) and the absolute value traded in 9M16 was 12.0% higher than Q315, maintaining ISY’s second place among its competitors. The equities result was supported by trading on behalf of Isbank clients. Commissions on those trades are also higher than for other clients, which contributed to a good result from brokerage commissions (Exhibit 7) and helped ISY to maintain an average commission margin of 4bp, above the sector average of c 3.6bp. ISY aims to regain equity market leadership in equity trading over the next year.

The company also captured a greater portion of the growing derivatives trading market in the year to 30 September with TRY89.1bn of trading, 22.1% above 9M15’s TRY73.0bn. Debt securities issuance has had a more mixed period. The total volume of debt securities issued in the nine months to the end of September 2016 rose 22% to TRY67.4bn, with ISY’s volume up 5.8%. This represented a drop in market share from 25% to 22% and was mainly due to one cancelled private placement; however, ISY remains the market leader. The company did not advise on any M&A deals in the quarter, leaving activity flat in 9M16 versus the same period in 2015. Regarding IPO activity, management reports that one planned offering in the telecoms sector was postponed pending the outcome of the US election and its impact on FOMC decisions; the IPO market may now pick up. The level of lending for equity margin trading recovered from a slight decline in H116 to close 9.5% up on 30 September 2015.

Assets under management grew markedly from Q315 to Q316. The overall market grew 20% to TRY101bn, driven mainly by a 31% increase in pension fund assets from TRY44bn to TRY58bn. ISY’s pension assets under management grew 32% to TRY10.7bn, 18.4% of the market. ISY’s pension fund assets under management have now averaged over 30% CAGR for five years and account for 40% of asset management fees. It is expected that this trend will continue, with these relatively stable clients making up a larger portion of the whole asset management client base.

The analysis of revenues in Exhibit 7 shows particularly good brokerage revenues, as noted above. Other contributors to the strong commission revenue result included a widening of foreign currency margin spreads and commissions on derivatives transactions. The latter was driven by trading outside Turkey, which makes up 50% of ISY’s derivatives activity, mainly in the US. This is a service that most of the competition does not provide and is therefore a significant differentiator for ISY. Interest and trading income, up 5% in 9M16 compared to 9M15, will likely show slightly less growth over the full year as a result of the reduction in interest rates in September.

Costs increased around 17% year-on-year, both in terms of the quarter and the nine months to 30 September, leaving the cost ratio at 79% for the year to date, in line with the H116 results. The increase in absolute costs came largely from higher transaction volumes and costs denominated in foreign currencies being relatively more expensive in Turkish lira in 2016.

Finally in this section we show net profit by business segment (Exhibit 9), summing to a consolidated net profit for Q316 of TY14.1m, more than double the level in Q315 and up 47% for the nine-month period. The main business, IS Investment, recorded an ROE of 17% in the quarter (compared with 12.5% ROE in H116), a level which management believes to be well above the sector average. IS PE’s loss in the quarter was less than either of the previous two quarters. The losses reflect the fact that most of its investee companies (which ISY consolidates) are still in the investment stage, as well as the challenging markets in which they operate. IS Asset Management continues to perform well as noted above. Efes NPL Asset Management is suffering from a delay in the collection of certain debts pending a court decision, expected in 2017, and slower collections more generally since the attempted coup in July. Steps are being taken to end the delays and a new general manager has been appointed.

We have updated our estimates to reflect a better-than-expected Q3 performance and refined assumptions for 2017. The latter include stronger performance at IS Investment next year: despite a subdued IPO market and a corporate bond issue being cancelled, IS Investment has performed above our expectations in 2016 and we expect this to be sustained in 2017. We have also reduced the losses we forecast at IS PE, again following better-than-expected performance in 2016. Offsetting those improvements to some extent, we forecast that Efes NPL will continue to make quarterly losses into 2017 as a result of the difficult business environment. Overall, this lifts our 2017 forecast attributable profit considerably, largely as a result of the outlook for IS Investment.

No other quoted investment banks have the same geographical profile and business mix as ISY, so we use a broader basket of European banks with significant investment banking business as peers (Exhibit 11). Compared with these, ISY has a much higher dividend yield, trades on a lower P/E multiple and a comparable P/B multiple despite earning a higher ROE (12% in 2017 according to our forecasts). To estimate the risk premium investors apply to ISY, we use a rearranged ROE/COE model to derive a COE of 15.2% for ISY at the current share price versus 6.5% for the European comparators, assuming 5% growth. This is above the 14.4% COE indicated by using the 11.2% yield on a 10-year Turkish government bond, the country risk premium for the country (6.4%) and ISY’s beta of 0.49 (both from Bloomberg). On the other hand, using the Bloomberg-derived COE of 14.4%, the current share price implies an ROE of 11.7%, whereas our FY17 ROE forecast is over 12% (note that IS Investment achieved an ROE of 17% in Q316). We note that this valuation is sensitive to the assumptions of growth, ROE and the risk-free rate. These could change materially depending on macro factors in Turkey or management decisions taken at ISY. A movement of 1% in the COE or ROE changes the indicated value by 14%.