Wednesday, August 11, 2010

Mobius: Turkey’s compelling story

Here's a new blog post by Mark Mobius of Templeton Emerging Markets Group. He is a brilliant investor for whom I have a great deal of respect. I had the pleasure of having met him in Istanbul at a private gathering. He follows his gut feel first and asks some brilliant questions. Having been a dealmaker in Europe and the Middle East, I wholeheartedly agree with Mark that you can not afford not investing and dealmaking in Turkey these days...and this is only the beginning.

Mobius: Turkey’s compelling story By Mark Mobius of Templeton Emerging Markets Group:

Why is Turkey so compelling an investment destination right now? Today Turkey’s macro fundamentals remain strong and there is a marked decoupling from Eastern European peers who now have serious debt sustainability and banking sector issues.

As a result of comprehensive structure reforms in 2001, Turkey now benefits from a domestic consumption-driven economy, sound fiscal outlook (low government and private debt), solid banking system, secular disinflation trend and favourable demographics.

The picture was not so positive just two decades ago; Turkey was faced with many challenges in the 1990s. Despite periods of high growth, in some years during that decade, rising macroeconomic imbalances hampered growth, resulting in recessions. The overall picture was one of large budget deficits, political instability, high inflation and interest rates. These variables characterized an unsustainable macroeconomic framework and financial crisis.

The turning point was after 2001 when the country initiated reforms that improved economic resiliency, productiveness and efficiency. As a result of strict government fiscal discipline, the budget deficit as a percent of GDP ratio, fell sharply from more than 10 per cent in 2002 to a current 5 per cent. Also the debt to GDP ratio dropped from 73 per cent in 2002 to its current figure, below 45 per cent. The currency has become more stable and interest rates have fallen from triple digits levels to single digits.

What are the attractive sectors?

The Turkish banks are very appealing. One of the most important aspects behind the v-shaped recovery in Turkey is the strong banking system. After 2001, Turkey restructured its banking system and realized important structural reforms that many countries like Greece are currently trying to implement.

Turkey still remains an under-banked market by global standards. The low penetration in almost all areas means that there is immense growth potential. The sector accounts for 89 per cent of GDP, far behind the EU average of 320 per cent. Likewise, volumes of mortgage loans at 5 per cent of GDP (EU average: 41 per cent) also proves the under-penetrated character of the sector. Turkish banks have increased lending rapidly in the last five years to a young productive army of domestic consumers. Over the past seven years, Turkey’s banking system’s overall balance sheet has increased at a compound annual growth rate of 22 per cent now reaching over 80 per cent of GDP up from 55 per cent in 2002. Turkish banks with their very high returns on equity and growth potential are still attractive compared to their EM peers.

Automotive manufacturing is another promising sector in Turkey. Turkish manufacturers are climbing up in the value chain in production and producing their own domestically designed cars. Turkey is becoming a major hub in automotive manufacturing and producers are benefiting from the network effect in the country. With its proximity to the large European market, Turkey is well placed to compete with European automobile exporters.

Risks that investors should be aware of

The pace of recovery in domestic demand may be impressive but external demand remains weak and a further slowdown in European economies would delay the recovery in exports. Turkey lags in technology development as well as energy and those structural issues need to be addressed properly and quickly.

The country also does not have enough commodity resources to support its growth, so rising commodity prices presents challenges. There is a need for more long-term capital investments and the current savings rate with under penetration of banking is relatively low. Foreign direct investments and greenfield investments have slowed since the crisis. There is thus a need to attract foreign capital with concrete plans to attract more sophisticated value added manufacturing. While Turkey excels at the lower end of the value chain in manufacturing there is a need to move up that value chain. These problems have resulted in a chronic external deficit which continues to widen leading to questions over the sustainability of the recovery.

Finally, there are political risks with a possible change in government. For the first time since 2002 (when the current ruling party, the AKP, came into power), as a result of the upcoming election next year there is a good possibility that Turkey will lose the benefits of a strong majority party capable of instituting wide-ranging reform. Turkey could end up with an indecisive coalition government.

What is Turkey’s investment potential vs other EMs?

Turkey’s population is still quite young. The median age is 27 years, which is well below that of the rapidly aging economies of China (34), South Korea (36) and Russia (38). It is now the fastest growing economy among the G20 major economies, excluding China, and compares with essentially no growth in 14 central and eastern European countries. While in the past Turkey’s economic and political orientation was toward Western Europe, it is now diversifying its political export partners in the Middle East and Mediterranean.

The government has signed free-trade agreements with Syria and Jordan and has been conducting negotiations with Lebanon recently. Those four countries also agreed to set up a joint cooperation council with plans to wider the scope to include other countries in the region.

Currently, Turkish equities trade at a discount relative to its EMEA peers. The lower inflation and low interest rates still have not been reflected in the valuation of Turkish companies. Given its strong macroeconomic characteristics there is a good chance that Turkey will obtain an investment upgrade and thus will have a lower equity-risk premium in the eyes of investors.

Mark Mobius is Executive Chairman, Templeton Emerging Markets Group.

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