Beware of short-term profit taking risk. Prefer ISCTR, TSKB and ALBRK

Beware of short-term profit taking, yet we still see value

Turkish banks have enjoyed a very strong rally that led to 20% nominal gain since May-end. Their PE discount to EM banks were 7% back in May and now they are trading at a premium. The CBT's dovish stance amid fears of global recession, strong foreign inflow in the bond market and less restrictive Basel II implementation were all acted as key triggers. Penciling in lower risk free rate assumptions (down from 9.5% to 8.5% in TL terms) and better loan growth prospects, we increase our price targets for the banking stocks by around 14%. We now see on average 19% return potential for the banks. We expect 7% earnings growth this year and 13% next year.

We now adopt a more balanced tone in our call for the banking sector. The stocks may be exposed to profit taking risk as Turkish banks currently trade at 12% premium on forward looking PE to EM banks compared to their historic 22% average discount (since 2006). Moreover, ex-ante risk free rate has already eased down to 1%, leaving only limited room to a further bond rally. On the upside, however, a potential rating upgrade for Turkey may bode well for the Turkish banks, leading to multiple expansion if not anything else. A further 100bps drop in risk free (which would zero out any real return on TL bonds) would enhance 2012E PE of Turkish banks to 11.5x, which is in line with the sector's peak multiple of 11.4x attained post 2008.

Top picks are ISCTR, TSKB and ALBRK

Among big caps, we prefer ISCTR and pencil in rather positive earnings growth forecasts (7% for 2012E and 14% for 2013E) for the bank. While these numbers take us above consensus, we believe that ISCTR has room to back its earnings growth with inherent efficiency improvements without relying extensively on macro top down drivers. We have already observed the bank's transformation project, launched in 2008, contributing positively to its financials in the last two quarters and the momentum is to continue and if the bank delivers such a performance, its historic valuation discount to sector average may well erode. Maintaining TSKB as Outperform on valuation grounds, ALBRK is the key beneficiary of changes in Basel II regime as it has no extra capital need in 2012. Based on 24% return potential, we upgrade the stock to Outperform.

To us, most of the positives are priced in for GARAN, HALKB and YKBNK. Admittedly, YKBNK may perform in toe with the success of YKSGR’s sale process, yet, EZ troubles may affect Turkish banks with European shareholders, psychologically. We downgrade GARAN, HALKB and YKBNK to Market Perform.

Revising earnings estimates upwards

We raised our 2012E and 2013E earnings estimates by 2% and 3% on average and the revised figures are 3% higher than the consensus, respectively. Our revised forecasts indicate 7% and 13% respective EPS growth in 2012 and 2013. We anticipate the banks in our coverage will post 0.3% QoQ and 2.5% YoY decline. ISCTR, HALKB, TSKB and SKBNK’s Q2 results are likely to be more positive, while GARAN, YKBNK and VAKBN’s profits are to be lower.

Basel II revision portrays more positive outlook for lending

We believe that Basel II will not be a burden for the system’s long-term loan growth. The recent removal of 110 bps negative impact means c. 10% additional loan growth potential. We believe that the banking sector can easily generate 1.8% (now 16.9% loan CAGR vs. 15.1% previous) additional loan growth (on average) each year over its potential that was pre-schemed Basel II outlook.