OTP seen profiting greatly from Hungary's monetary tightening

Analysts at Morgan Stanley analysed how Polish, Hungarian and Czech equity markets typically perform when there is a period of structural upswing in interest rates: They consider the last three periods of rising interest rates in Poland, Hungary and the Czech Republic, beginning at the following dates:

• Poland: July 2004, April 2007 and January 2011;
• Hungary: June 2006, April 2008 and December 2010; and
• Czech Republic: June 2004, October 2005 and August 2017.

The analysts put the spotlight in the period six months before and six months after the first rate hike.

• In Poland, they find that in the aforementioned period, local stocks on average posted positive USD returns on an absolute and relative basis versus EM.
• In the Czech Republic, on an absolute basis, local equities on average posted positive USD returns in the period before and after the first rate hike. On a relative basis versus EM, the performance was slightly positive before the first rate hike, while after the event it was broadly flat.
• In Hungary, results are more mixed. Before the first rate hike, USD performance in absolute and relative terms was broadly flat until one month before the actual rate hike - when stocks, on average, underperformed for the following two months. After this period, Hungarian stocks maintained a positive USD performance on an absolute and relative basis for the following four months. In two of the three periods, the analysts observed underperformance of local equities versus EM peers around the time of the first rate hike.

Overall, they observed that approaching a rate hike there’s sell-off on the Budapest Stock Exchange (BSE), but investor sentiment cools off within a few weeks and the BUX index starts to rise sharply after that.

The relatively positive performance of local stocks around rate hikes could be a reflection of the large weight of financials in the index for each country. For instance, financial stocks are 56% of MSCI Hungary, 54% of MSCI Czech Republic and 48% of MSCI Poland, Morgan Stanley said. This does not occur by chance, considering that the profitability of such companies typically improve when interest rates are raised.

With this in mind, the analysts also look at the performance of financial stocks relative to the MSCI EM index in each country. In Hungary, again similar to the broad index, financial stocks underperformed EM around the first rate hike, but were strongly positive one month after the event. Note that in Hungary’s case, the MSCI index consists largely of OTP.

• Morgan Stanley shifted its preference in CEE away from pure play Polish banks to banks with a pan-CEE footprint.
• It keeps its preference for Erste over Raiffeisen Bank Internatinoal as its simpler business model, and the growth outlook for the CEE region along with higher rates in the Czech Republic, should prove supportive to earnings.
• MS reiterated its Overweight rating on OTP given that our economist expects significant tightening of Hungarian interbank rates in the medium term, and to reflect the structural gearing of Hungarian bank margins to higher rates.
• Morgan Stanley’s order of preference in CEE is OTP (Overweight), Pekao (Overweight), Erste (Equal-weight), PKO BP (Equal-weight), RBI (Underweight), Alior (Underweight).

MS updated its models and cut its 2019 and 2020 EPS estimates for OTP by 2% and 1% to HUF 1,111 and HUF 1,178, respectively. It has also trimmed its target price for OTP to HUF 13,200 from HUF 13,500 previously.

As for other stocks, MS has three scenarios for OTP too:

• Bull: OTP uses excess capital to increase market shares in countries where it is currently subscale, thus bringing cost/income in line with the systems long term average. Target price: HUF 18,000.
• Base: Synergies begin to materialise next year from Croatian and Serbian acquisitions, Bulgarian synergies from 2020. OTP makes no further acquisitions but recent acquisitions yield cost synergies. Target price: HUF 13,200.
• Bear: For OTP this means a deceleration of loan growth and extension of low rates, cost of risk at cc. 130bp over average gross loans in 2020e - breaching management's expectations of 60-80bp. Target price: HUF 5,300.

• Tags:
• banking sector,
• morgan stanley,
• companies,
• research,
• central and eastern europe,
• analyst,
• market,
• equity,
• otp