Turning to the markets, by now you are well aware of our EM leanings as we have been beating a dead horse for well over 6 months on the theme. One of those EMs has been making some global news lately, so we figured we’d do a quick update. Let’s dig in…
You’ve probably seen that Turkiye got some volatility in the last 10 days. For those who were under a rock, Istanbul Mayor Ekrem Imamoglu and another approx. 100 people including his close advisors, municipal employees, ‘friendly’ construction company owners, local opposition media members and journalists were taken into custody. Imamoglu was later jailed on corruption charges. We will leave it to you to become local frontier market expert on your own time, we’ll keep this short and to the point. Erdy made a typical move to quash yet another potential political opponent, while also solidifying his power by increasing his control in Istanbul municipal administration. Now, we’re not going to go into whether the corruption charges have merit, or the legal due process is being raped or not. We are market guys and looking at this only from a trade perspective. But we have to admit that this has been one of the more entertaining unrests in Turkiye that we’ve followed…
We were a bit surprised by the severity of Erdy’s move and more so by the timing. Parliamentary elections are not until May 2028 (an early election between Nov 2027 and Feb 2028 is likely as Erdy cannot be nominated in regular elections) We knew Erdy wanted to hinder Imamoglu’s increasing popularity, and he even made sure Imamoglu can never run for President by annulling his College Diploma couple weeks ago. The guy’s presidential aspirations were done right there, and the market didn’t even flinch. So we are scratching our heads on why Erdy hit the nuclear option with basically nothing incremental to gain, and made the Imamoglu exponentially more popular and gave him the political underdog charm. Controlling Istanbul’s municipal government is like sitting on a goldmine, Erdy knows this well with his term from 1990 to 2002. Maybe he and his cronies had been locked out of the honeypot for too long, and they wanted back in. In any case, if you are going to be a harsh critic of Erdy and challenge him into taking over his throne, its not heard to guess where you will end up…
What does it mean for the market? Let’s turn back to October and revisit the initial thesis. You already know the reasons for our bullish view on EMs. The idiosyncratic case with Turkiye rests in three main pillars. First and foremost is the tectonic shift in the size of local investment landscape that already took place, but most market players are failing to notice. In 2018, the total AuM in all local investment funds and retirement accounts were roughly $18bn usd. Today, that number is $150bn-$160bn and their equity allocation is not only underweight, but close to historic lows. Keep in mind that TR is a very tight float market, all the public free float in BIST100 index is $68billon usd. The 45% overnight rates are going to be cut with falling inflation. Trusts us when we say this, Erdy is not a high real-rate kinda guy, but surely we won’t go back to -75% real yields either. Once these funds switch back to equal-weight equities trying to avoid bag holding negative yielding fixed income, there will be some really interesting charts..
Second is the IFRS-IAS29 inflation accounting rules that obfuscates the true earning power of some of the most valuable Turkish companies. Look, we have talked to enough local audit experts, company CFOs and even Turkish SEC consultants to tell you confidently that no one really f*cking knows. They are all winging it until the IAS29 implementation period is over in 2026/27. Most of their focus is on maximizing monetary loss adjustment line items to minimize cash taxes payable, which significantly decreases their earnings. But here is the good part. For years we have been following the market and one thing that all market participants agreed was the Turkish accounting standards (TFRS) are overly complicated. The banks had already switched to full IFRS in 2009, which made them palatable to foreign investors. The IAS29 hyper inflation adjustments will end but the implementation of IFRS will continue which will help understand financials easier and make BIST100 more attractive to all investors.
We are going to keep beating a dead horse here. We simply cannot think of a country that is better positioned to reap the benefits of the prevailing geopolitical shifts. Erdy is Mr. Useful again, and Trump made it very clear even at the peak of the protests this week that he intends to work very closely with him. United States is the largest army in NATO and Turkey is number two. Trump wants to take US troops out of Syria. He also wants to make sure that nothing can threaten Israel’s safety. Both these plans have a large role for Erdy. Its already a known-known that US and TR are very close to ironing out last difference on Syria, and US troops will soon leave, leaving the job to the Turks. Major win for Trump, and a good strategic position for Erdy. While the Israel-Hamas-Iran situation is once again heating up, we would encourage you to follow every single word out of Steve Witkoff. Find some time and listen to the full interview he did with Tucker Carlson. It is apparent that he talks for Trump. Look, US needs strong and loyal allies in Middle East. Saudi cannot be controlled. And Iraq? well let’s just say after Saddam they won’t make that mistake again in this century. Qatar and the Emiratis are ‘nice to have’s but they have no manpower on the ground, what they do have is intelligence and money which US doesn’t need more of. That leaves Egypt and Turkey. Listen to Witkoff’s comments on why the complicated situation in Egypt makes them a tricky ally. In short, US and Israel’s best ally in ME is Erdy and Turkiye.
Imamoglu winning Presidential elections and turning Turkiye into Middle Eastern Sweden was never a part of the thesis. Waterfall of foreign inflows lifting the market was never our base case. Turkey comes with Erdogan. At least for now. That’s also why you get a G7 country with second largest population in Europe and second largest army in NATO at 4.3x P/E. That’s IAS29 adjusted, on an unadjusted basis we are probably close to 3.4x NTM. US is at close to 21x and MSCI Emerging Markets is at 12.3x. Today you can buy TR at close to 70% discount to Emerging Markets.
Just to be clear. We are not saying TR market multiple goes to 12.3, although we think EM market multiples as a whole probably has some upside. Say XU100 (TR) EPS is $55 bucks. We think EPS goes to maybe $70 – $75 in couple years, and prob higher depending on where TR rates and DXY settles. What’s the right multiple for a growing democracy-lite with strong tailwinds and inflows? We truly don’t know. Vietnam with their one party (Communist Party of Vietnam-CPV) is at 14x. Dubai (DFMGI) is at 10x but most companies that you’d own, like owner of the exchange- DFM- is trading at 28x. Even at a mere 6x multiple, we get XU100 at $450 vs $240 today. And keep in mind that that’s the entire index, which has close to 100% upside. We think most our names will be up 150%-200% when the index doubles.
So is the volatility over? Probably not. But we think the worst is behind. The Treasury/ Central Bank team has been doing a good job keeping the Lira steady in the face of carry trade unwind. We think Lira could even strengthen slightly in the coming weeks. That’s also why the 5-year CDS is not out of control, though it made a scary move higher initially.
300bps levels is really not that crazy for TR. Keep in mind that the US volatility also didn’t help going into the close on Friday. CB has ample reserves. Swap channels are open and high ON rates still makes TR pretty attractive from a carry trade standpoint. Just two weeks ago, so called experts were sure that head of Treasury, Ex Merrill guy Simsek would never be able to raise rates again, even if we had another inflation scare. This week he raised rates twice and the market welcomed the return back to orthodox policies and Erdy letting Simsek do ‘Whatever it takes’. In short, we fully expect the CDS come down, Lira to keep rangebound and rates come back down to pre-turmoil levels in the next couple months.
Overall, we think we get meaningful de-escalation starting next week. Monday is the start of Eid-al Adha, so the holiday will help ease tensions. Erdy will likely try to show some good faith by releasing some student protesters so they can go back to their families to observe the Bayram. Imamoglu’s situation turns into a legal muppet show that will drag on for months. Obviously, it is very difficult to say what the outcome will be, but we think the bottom was the 3-limit down days after the arrest. Say Imamoglu is kept in jail. Erdy and Simsek props up the market with measures they have been taking since last week. Meanwhile, the geopolitical tailwinds increasingly translate into increased earnings in our companies. Turkish Airlines (THYAO) is now starting flights to Damacus. The cement companies have already started receiving orders to rebuild Northern Syria. Demand from Ukraine and Israel(Gaza) will be nice incremental addition. We keep a close eye on tourism numbers and anticipate that Russians, historically the second largest visitor group that is down 40%, will normalize. Also excited about the post-peace deal re-rate in some stocks with significant Russian businesses, most importantly a TK-listed brewery that is the #1 player, by far, with 30% market share in Russia, a white goods company that purchased Whirlpool Russia for next to nothing, or a Real Estate play that is the leading office and residential landlord and a big infrastructure construction company, sorta Russian lovechild of SL Green and Equity Residential. These are irreplaceable assets. We probably get some good news from US-TR relations after Trump -Erdy meeting next month and even might get defense CAATSA sanction relief. Say somehow Imamoglu is freed and becomes the next president? Great, market multiple prob goes from 4x to 12x with foreign money that left in 2018 trying to get a piece of an EM democracy comeback story and most of our names are probably 5-baggers. Is that our base case? Absolutely not. But bottom line, it looks like the Erdy discount is already well factored in, and now the question is whether TK will be a good run or a homerun.
