Why we are building contrarian positions in unloved Turkey

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Why we are building contrarian positions in unloved Turkey

Lukas Schmitz (pictured) is manager of the SWMC Emerging European Fund and gives his view on Turkish equities.

I recently attended a conference in Istanbul, to try and get a better sense of the current political and economic situation in Turkey.

Remember, it has only been a few months from the attempted coup. My first, and most obvious, observation was that I was the only non-Turkish investor in attendance – with the usual others having either cancelled or never expressed any interest in the first place.

Turkey has been underperforming against the other eastern European markets since the July coup attempt – with the BIST 30 falling more than 10% in euro terms, compared to 4% rise for the broader eastern European market.

Turkey’s economy is similar to that of Poland and Greece in in terms of GDP per capita, but has much higher inflation than most other emerging European countries. The country is dependent on foreign investment due to its current account deficit, so the political situation must be watched closely.

President Erdogan seems intent to obtain more power – next on the agenda seems to be a presidential executive system – and pull away from the EU. This is leading to a drying up of foreign investment and a depreciating lira. The lack of international interest in the conference emphasised how far Turkey has fallen from grace with the investment community.

However, compared to other Eastern and Western European economies, Turkey still has an underpenetrated economy across a number of sectors – such as retail, banking and pensions. Turkey is also in a much better situation in regard to demographics than other eastern European countries, with a very large young population. In addition, the economy is still growing at a decent pace.

While political risks, a potential downturn in the economy and an uptick in inflation are all real, as an investor it is important to remind yourself there are currently a large number of unloved companies offering strong long term prospects. If looking at over a multi-year timeframe, this could be an interesting time to build positions in high quality companies likely to benefit from the positive drivers.

For example, we recently invested in the car manufacturing company Tofas, a producer of small and medium sized cars and light commercial vehicles for Fiat Chrysler Automobiles. The latest range of Fiat models are selling better than anticipated, resulting in over 100% capacity utilisation at the Tofas plant, as well better pricing powers and a decline in bulk sales, improving margins.

Additionally, the largely euro-denominated revenue is a nice hedge against the potentially further depreciating lira.

We are optimistic on select banking stocks in the country, such as quality multi-channel bank Garanti. The second largest bank in Turkey, Garanti has the highest Common Equity Tier 1 ratio, as well as lower NPLs (non-performing loans) and cost of risk than the overall sector. The bank has a well-diversified loan book, with one of the lowest consumer and unsecured-consumer exposures.

Garanti is also witnessing strong growth in deposits, loans and fee income – while it is one of the front runners in investments and development of technology.

We also have a position in TSKB, or Turkiye Sinai Kalkinma Bankasi.

TSKB has a slightly different business model to the likes of Garanti, as it is a development bank and investment banking operator. A significant proportion of its long-term financing is guaranteed by the Treasury in order to fund large industrial and infrastructure investments.

TSKB is also much more conservative to the high street banks, with the lowest NPL ratio and cost to income of all banks in Turkey, while it also offers the highest return on equity.