31 August 2006 Global Emerging Markets Turkey +PSFEP6IWIEVGL Turkey Informer Equity market drivers Turkish equities have bounced back strongly from their May lows, but nevertheless still face some tough structural headwinds. Most crucially, we think the global environment still creates challenges for current account-deficit countries, although there are both upside and downside risks here. Domestically, tight monetary and fiscal policies create continued downside risk to growth and earnings estimates. There is a liquidity risk as well, in that the market remains over-owned. The change in the macro environment also threatens to raise the political temperature going into next year’s elections and will probably make investors focus more on political risk than might otherwise be the case. That said, valuation provides some comfort. On a PE basis, Turkey enjoys discounts to EMEA of 7% for 2006e and 12% for 2007e. Moreover, we see about 19% upside to fair Bulent Yurdagul* Analyst value for the market, both for banks and non-banks. Of course, if growth is weaker than HSBC Yatirim Menkul Degerler A.S. we expect, earnings erosion would undermine the room for manoeuvre on valuations. But (Turkey) equally, further Turkish lira (TRL) appreciation could enhance the interest rate and +90 212 366 16 04 [email protected] growth outlook – both of which would, in turn, boost valuations. Cenk Orcan* In view of this outlook, we keep the Turkish market on a Neutral weighting. Analyst HSBC Yatirim Menkul Degerler A.S. Top stock picks (Turkey) +90 212 366 16 05 Banks – our top picks remain Garanti and TEB on prospects of strong growth under the [email protected] global expertise of new JV partners, GE and BNP, respectively. Both banks have Murat Ulgen* attractive multiples, trading at single-digit PEs on our 2006 and 2007 estimates. Potential Chief Economist HSBC Yatirim Menkul Degerler A.S. upside to our two-year notional target price is 32% for Garanti and 51% for TEB. (Turkey) +90 212 366 16 25 Autos/Consumer – consumer demand, especially for autos, should revive from Q4 [email protected] onwards as rates stabilise and TRL recovers. Demand for white goods is still supported by John Lomax* ongoing momentum from the last two years’ construction boom. We find value in blue GEM Strategist chips Arcelik and Ford Otosan. Tofas should not disappoint investors currently buying HSBC Bank plc (UK) into its long-term turnaround prospects on new models. +44 20 7992 3712 [email protected] Construction/Building materials – we continue to favour Trakya Cam as it remains a * Employed by non-US affiliate of strong beneficiary of ongoing strong momentum in the construction sector. HSBC Securities (USA) Inc, and is not registered/qualified pursuant to NYSE Conglomerates – Sabanci Holding is our top pick because of its 30% discount to target and/or NASD regulations. NAV, which we do not think is justified, given near-term potential catalysts such as bids Disclaimer & for electricity tenders. Disclosures. This report must be read Small Cap – We like Anadolu Cam because of its healthy regional expansion, Netas on with the disclosures and prospects of a speed-up in telecom infrastructure spending and Eczacibasi Ilac due to our the analyst certifications in strong growth outlook for Turkey’s generic drug market and the company’s M&A mandate. the Disclosure appendix, and with the Disclaimer, that form part of it. Global Emerging Markets Turkey 31 August 2006 Strategy 3 Recent company reports 21 Recent sector reports 33 Banks 34 Automotive 41 REITs 44 Economic environment 47 Valuation & performance 55 Disclosure appendix 60 Disclaimer 63 2 Global Emerging Markets Turkey 31 August 2006 Turkey: hostage to global By contrast, an elongated peak – where rates have economic trends to remain high to fend off the residual inflationary pressures engendered by high commodity prices – Turkish equities have bounced strongly from their would be much less positive, and would keep the May lows, but nevertheless still face some tough pressure on current account-deficit asset markets. structural headwinds. Most crucially, we think the This would mean ongoing pressure on Turkish global environment still creates challenges for macro – and in particular the delicate balance current account-deficit countries, although there between the TRL exchange rate, inflation and the are both upside and downside risks here. Turkish central bank’s inflation target. With Domestically, tight monetary and fiscal policies Turkish inflation running at 12%, meeting the create continued downside risk to growth and central bank’s 4% target for the end of 2007 is earnings estimates. There is a liquidity risk as already challenging (even allowing for a 2% well, in that the market remains over-owned. potential uncertainty band). Renewed exchange However, these risks are, to some extent, already rate weakness would play on this vulnerability. factored into valuations – hence we remain Neutral on the market as a whole. This creates persistent risks for the key drivers of Turkish equities. In particular, a more difficult In terms of the global environment, it seems macro environment would threaten the growth, inevitable that the world economy will slow – but exchange rate and interest rate projections that for Turkey the key issue lies in the kind of landing feed into our bottom-up forecasts. On this front, which results. A smooth cyclical top, where US we are currently expecting 5% GDP growth this interest rates come through quickly to support the year and 5.5% in 2007e, with another 100bp US economy could, in principle, be quite positive for increase in interest rates, to 18.5% by the end of Turkish equities. Under this scenario, the Turkish 2006. So a further hit to the exchange rate, for lira (TRL) would appreciate versus the USD, example, would force up inflation and interest pushing down Turkish inflation and interest rates. rates and further depress the growth outlook. Turkey in a global context __________________ PE ___________________ _______________ EPS growth ________________ PEG 2005a 2006e 2007e 2005a 2006e 2007e 2006 Turkey 12.5 11.7 10.0 15.1 6.8 17.3 0.9 Czech Rep. 21.0 16.6 9.8 23.3 7.4 2.6 1.0 Egypt 15.5 13.7 11.4 80.2 12.9 20.2 0.7 Israel 7.4 14.1 13.1 10.3 -47.1 7.7 1.8 Hungary 10.8 10.1 9.8 23.3 7.4 2.6 3.9 Poland 14.0 11.8 11.3 16.5 18.0 4.7 2.5 Russia 13.7 12.0 11.8 25.5 14.5 1.4 8.8 South Africa 16.9 13.2 10.6 11.1 28.6 24.5 0.5 EMEA 14.5 12.6 11.3 16.5 16.9 11.4 1.1 EM Asia 13.5 12.5 10.9 -0.1 8.1 14.5 0.9 Latin America 11.4 9.7 9.0 27.8 17.3 7.9 1.2 Source: HSBC estimates (prices as of 25 August 2006) 3 Global Emerging Markets Turkey 31 August 2006 There are already certain risks to GDP forecasts. Gulf investors participated in the rally. With On the positive side, Turkey has been able to nominal and real interest rates set to remain much grow rapidly in the past, with real interest rates at higher than previously expected, it’s difficult to current levels. Hence, in this sense, the recent see local mutual funds boosting equity exposure. tightening in monetary policy should not weigh Indeed, the risk is that, given the abrupt change in too much on growth. However, the most dynamic the Turkish macro environment, foreign funds part of last year’s performance was in interest could use the current rally to sell. In general, the rate-sensitive sectors (like construction). To the liquidity obstacles for Turkey could be quite extent that it was because the private sector has strong. been convinced of prospects for ongoing interest That said, valuation provides some comfort. On a rate convergence, the recent tightening in PE basis, Turkey enjoys a discount to EMEA of monetary policy may, in fact, have a about 7% for 2006e and 12% for 2007e. disproportionately negative impact. The data Moreover, we see about 19% upside to fair value available since the latest round of exchange rate for the market, both for banks and non-banks. Of weakness do not, so far, provide a clear picture of course, if growth is weaker than we expect, which of these stories is more accurate. Still, one earnings erosion would undermine the room for would expect GDP trends to be the primary manoeuvre on valuations. But equally, further influence on the quoted corporate earnings TRL appreciation could enhance the interest rate outlook. So any shortfall in GDP would similarly and growth outlook – both of which would, in damage earnings prospects. On this count, bear in turn, boost valuations. mind that Turkey already has the most negative trend in terms of earnings downgrades of any In view of these risks, we keep the Turkish market GEM market. on a Neutral weighting. The change in the macro environment also Equity performance summary threatens to raise the political temperature going Performance summary into next year’s elections. Higher inflation and -1 wk -1M -3M -12M Y-t-d weaker growth could prove to be complicating Absolute % factors in the spring presidential election and MSCI GEM 0.3 5.8 2.9 26.1 9.3 MSCI EMEA -0.8 6.9 -0.8 29.7 7.2 autumn general election, and are likely to make MSCI Turkey -0.5 14.9 -4.2 19.8 -14.9 investors focus more on political risk than might Relative to GEM % MSCI Turkey -0.8 9.2 -7.1 -6.2 -24.1 otherwise be the case.