Koc Holding AS

IST:KCHOL.E

Earnings Call Transcript 2019-Q1

[Operator]

Ladies and gentleman, thank you for standing by. I am Gelly, your Chorus Call operator. Welcome, and thank you for joining the Koç Holding conference call to present and discuss the first quarter 2019 financial results. [Operator Instructions] This call is being recorded. The presentation will be followed by a question and answer session. [Operator Instructions]

At this time, I would like to turn the conference over to Ms. Gizem Poyraz, Investor Relations Manager at Koç Holding. Ms. Poyraz, you may now proceed.

[Gizem Bodur, executive]

Thank you. Welcome, everyone, and thank you for joining us this evening. This is Gizem, IR manager of Koç Holding. I have here with me our CFO, Mr. Ashaboglu; our IR coordinator, Nursel Ilgen; and Fatih Sertdemir, our Finance Coordinator.

I would like to remind you that our presentation and the Q&A session might contain forward-looking statements. Our assumptions are based on the environment in our businesses as we see them today, and this might be subject to change.

Before the call, we have sent our e-bulletin, which contains a link to our earnings presentation. After the call, you can also access a replay facility on our website.

Now I would like to hand over to Mr. Ashaboglu to start the presentation by commenting on our positioning and recent actions. At the end of the presentation, we will have a Q&A session as always.

[Ahmet Ashaboglu, executive]

Thank you, Gizem. Welcome, everyone.

Let's start on Slide 2. At Koç Holding, our main aim is to ensure sustainability by deploying our capital in a diversified and value-generating manner. In this regard, we manage our balance sheet to ensure that we always remain resilient against market volatility. One of our key principles is to have a sustainable and efficient level of net cash at the holding level. We manage this by taking into account 2 levers: a, our dividends ins and outs; and b, our selective capital deployment.

In terms of our dividend income, we have seen a doubling in 2018, which we have, to a large extent, sustained this year despite the volatile environment.

This year's figure does not incorporate the dividends of our unlisted companies as well as potential dividends for the remainder of the year from some of our companies that distribute dividends twice a year as per our past year practices.

Despite the fact that this year, Arçelik and TürkTraktör decided not to pay any dividends for balance sheet strengthening purposes given high interest rate environment as well as sluggish domestic demand for their sectors, our dividend income was still solid. This was a good testament to our diverse portfolio, enabling a sustainable dividend flow. Another factor which contributes to the sustainability of our dividend flows is the fact that around 80% of our dividend income is derived from companies which have FX or FX-linked revenues. In summary, this dividend level can be considered as a new sustainable level as we expect the free cash flow generation for our underlying companies to be solid also in 2019.

In terms of our dividend payments, we manage this taking into account, one, our dividend income; two, the investment opportunities in the market; and three, our balance sheet management and risk principles, including our net cash position.

We have been consistent in this regard over the years. And this year's figure is aligned with our historic average payout ratio of 20%.

At the holding stand-alone level, we like to keep a certain level of cash to serve as a war chest against volatility as well as firing power should investment opportunities arise.

As of the end of March 2019, our net cash position at the holding level was $550 million. Including our dividend payments and dividend inflow from Ford Otosan, which happened at the beginning of April, our adjusted net cash position becomes $418 million. As you know, in January 2019, we participated in Yapi Kredi Bank's AT1 issuance with $200 million. Therefore, including YKB AT1 investments, our net cash reached $626 million, again, for the adjustment for the beginning of April cash-ins.

Overall, although 2019 might entail some challenges, we are well prepared with our solid and diverse businesses and tight risk control. Furthermore, given our strong cash position, we are also in a position to benefit from growth opportunities as they may arise.

On Slide 3, you can see the main pillars of our solid balance sheet. As you all know, prudent management has always been a key focus area. At the holding stand-alone level, we have close to $2.7 billion of gross cash and 78% of this position is kept in hard currency. Keeping an efficient level of net cash has been our approach for many years and allows us to maintain our resilience.

In terms of our funding and controlling level, we have 3 Eurobonds, including our latest Eurobond issuance of $750 million in March of this year. The issue was a 6-year note priced with the coupon of 6.5%. The issuance allowed Koç Holding to prefund the Eurobonds, totaling again $750 million due in April 2020, 1 year in advance. The funds are mainly being kept in short-term USD time deposits. We have no other debt at Koç Holding standalone levels.

As a reminder, Koç Holding's ratings are BB- for S&P and Ba2 for Moody's, and they remain 1 notch above Turkey's sovereign rating.

We also have well-defined and prudent risk management policies that are applied regularly and monitored on a combined basis as well as at each underlying company.

In terms of liquidity, leverage and foreign exchange position, we are at conservative levels. On a combined basis, our current ratio is 1.4x, and our net financial debt over EBITDA is also at 1.4x.

Note that, these figures excludes IFRS 16 effect. As you all know, IFRS 16 requires rent expenses with long-term contracts to be reflected in financials. All in all, application of IFRS 16 has a negative impact on financial debt and a positive impact on EBITDA. At Koç Holding combined level, the effects of IFRS 16 are negligible on net financial debt over EBITDA ratio.

The first quarter is not a good indicator for assigning the impact without seeing full year EBITDA since we calculate and still we calculate that the full year impact will be quite negligible, below 0.1x, again, as a net financial debt over EBITDA KPI.

In terms of FX, we have a policy of keeping a natural position, and we remain well within our risk management rules. Going forward, we will continue to maintain the solidity of our balance sheet as we have always done in the past.

Now I would like to briefly summarize our first quarter performance, focusing on our main sectors. Let's start with energy and Tüpras on Slide 4.

The domestic demand for refined products continued its downward trend in the first 2 months of 2019. We saw 5% year-on-year decrease in diesel and 1% decline in gasoline sales volumes. On the other hand, jet fuel consumption increased by 4%, mainly thanks to strong tourist arrivals.

Tüpras' domestic sales volume was flat, while export volume almost doubled, leading to 17% rise in total sales volume. When we look at the refining margins, we see $0.4 per barrel decline in the Med Complex margin to $3.6 per barrel due to lower gasoline [ crack ] margins. On the other hand, Tüpras' net refining margin was $0.6 per barrel higher than Med Complex margin, thanks to advantages in product yield -- as you know, our white product yield is 77%, and crude selection ability of the company. Tüpras' overall net refining margin amounted to $4.2 per barrel versus $4.8 per barrel during the same period of last year, mainly due to narrow differentials as well as the maintenance in our big units of Residuum Upgrade Project.

In terms of capacity utilization, Tüpras operated at 94% capacity utilization rate based on 30 million tons for the first quarter of 2019. And this is despite the fact that the RUP, our residuum upgrade unit maintenance took place in 2 months of the first quarter. The maintenance started at the end of February and currently is at final stages.

Although this stoppage will have a negative impact of around $40 -- $40 million on EBITDA per month, upon its completion, Tüpras will be fully positioned to take advantage of the upcoming IMO 2020 regulation change.

In terms of expectations for 2019, the Med Complex margin is forecasted to be at between $3.75 to $4.25 per barrel, while Tüpras' net refining margin expected to be $6 to $7 per barrel. Capacity utilization will be around 95% to 100%.

On the LPG side, consumption decreased by 2% in the first 2 months of 2019. Aygaz, the leading player in the LPG sector, focused on profitability and, therefore, its sales volume recorded 4% contraction.

For 2019, Aygaz expects 2% to 3% contraction in sector volumes while, for itself, market share is expected to remain flat.

Accordingly, looking at energy segment contribution to Koç Holding, we can see that its share in combined operating profit and consolidated net income are 25% and negative 17%, respectively.

Bottom line was negative, mainly due to the negative impact of plant residuum upgrade project unit maintenance as well as tightened crude oil differentials. Higher natural gas prices and sharp FX losses occurred in March that will be recovered via natural hedge mechanism in the upcoming quarter.

Let's move to Slide 5 and discuss developments in auto segment. In 2019, Turkish auto market continued to be impacted by rising currency and interest rates. After 35% contraction in 2018 for the whole year, the first quarter witnessed 45% year-on-year decline in sales volume. In this period, we focused on profitability in the domestic market and managed to take advantage of government incentives. Special consumption tax since November of 2018 and scrap incentives since March 2018 were available in that period.

Accordingly, our market share in the domestic market increased by 6 percentage points to 28%. On the export side, our group market share remained solid, especially supported by strong performance of Ford Otosan. During this period, Ford Otosan increased its sales volume by 7%, thanks to ongoing growth in the European commercial vehicle markets and market share gains.

Tofas, on the other hand, witnessed 37% decline in its export volumes, but Tofas management keeps its full year guidance of 14% year-on-year decline.

Looking at the total revenue performance of Ford Otosan and Tofas, we can see 27% growth and 10% decline, respectively. International revenues were the main driver for both companies, supported by euro-based cost-plus contracts and, in the case of Tofas, also take-or-pays. These contracts allow our auto companies to remain resilient in periods of TL depreciation. For both companies, International revenues contributes at around 80% to 85% to their total revenues.

Regarding 2019 expectations, both companies made an upward revision to their production guidance. This revision stems from better-than-expected overall export performance for Ford Otosan and domestic sales for Tofas.

Due to high interest rates and weak demand, we expect 30% to 35% contraction in the domestic markets. For Ford Otosan, Ford Otosan expects its retail sales volumes to be around 40,000 to 50,000 units with 35% decline, while Tofas revised its exports by 20,000 units upwards to 60,000 to 65,000 units, corresponding to only 14% year-on-year decline, mainly thanks to competitive pricing of its passenger cars. The last amount for Tofas, of course, was for the local market not exports, I apologize for that.

Regarding exports, Ford Otosan raised its export volume guidance by 20,000 units to 345,000 units. Tofas, on the other hand, expects around 14% volume contraction to around 210,000 units, but the P&L impact will be limited, thanks to take-or-pay contracts, which are in excess of this figure. All in all, solid export contracts and cost discipline will ensure resilience for our auto companies in the remainder of the year.

Let's also touch upon our tractor company, TürkTraktör. In the first quarter, the demand was severely impacted by rising input prices and low farmers' confidence. During this time, TürkTraktör domestic sales volume declined by 70% year-on-year. This was partly offset by strong export sales with 26% rise year-on-year.

Accordingly, TürkTraktör revenues declined by 22% in total year-on-year. Profitability was also impacted to a great extent by weak demand dynamics in Turkey. For 2019, TürkTraktör tractor is expecting the market to decline by around 45% and its sales volume to decline by 28% while always maintaining focus on profitability. The company's export volume is expected to remain flat despite its strong performance in 2018.

In summary, we see solid performance from the automotive segment of Koç Holding. Overall, the auto segment accounts for 29% of our combined operating profit and 40% of our consolidated net income. The auto segment's operating profit increased by 17% year-on-year. The main drivers of this positive performance were solid international revenues and export contract as well as cost discipline. Against this strong performance, our auto segment's consolidated net income decreased by 28% year-on-year, mainly due to one-offs linked to the purchase gain on acquisition of car rental business in Greece by Otokoç in 2018. Excluding this one-off, the auto segment realized a mere 3% year-on-year decline in consolidated net income.

On Slide 6, we can look at the Consumer Durables segment. In the domestic market, white goods sales decreased by 11% year-on-year in the first quarter due to weak private consumption. On the other hand, special consumption tax cuts since November 2018 has a positive impact on the market. In International markets, in the first 2 months of 2019, West Europe recorded a slight increase of 1% year-on-year with U.K. growing by 7%, while Eastern Europe remained strong with 3% growth. However, white goods exports in the sector declined by 3%, mainly due to high base impact with 11% year-on-year growth in the first quarter of 2018.

Looking at Arçelik revenue figures, domestic revenues increased by 16%, thanks to pricing focus and outperformance of the market with 2% year-on-year growth in unit sales. Arçelik realized significant market share gains in this period of about 7 percentage points.

On the International sales front, which constituted 68% of total volume -- which constituted 68% of our total, revenue growth was stronger at 39%, incorporating solid organic growth of 9%. In this period, Arçelik kept its market share almost flattish in major export markets but managed to increase its price index in most of the countries.

In terms of profitability, easing in the raw material prices and strong sales performance were among the positives of the quarter. However, this was offset mainly by rising TL-denominated operational expenses such as wage hikes. Net income growth was higher due to one-off FX gains at the end of March and some derivative gains in the swap market.

The company's working capital to sales ratio decreased further to 27.3% from 28% at the end of 2018 and versus 31.6% in the first quarter of 2018. And this was mainly due to better payable and inventory management.

Arçelik's management aims to keep these levels going forward. Leverage also stayed at sustainable levels with net debt over EBITDA ratio of 2.3x versus 2.4x at the end of 2018 and versus 2.8x in the first quarter of last year, while the company successfully rolled over most of its debt year-to-date. Effectively -- effective hedging policy was intact as always with some long FX position at the end of first quarter due to the Bangladesh acquisition, which come down to its usual square position after the deal closed in early April.

Regarding 2019 expectations, the domestic market is foreseen to decline by 10% year-on-year, but revenue growth to be around 25% to 30% on solid positioning in the domestic market, ongoing strong performance in International markets and consolidation of Bangladesh operations. EBITDA margin expectation is revised by 1 percentage points to 11.5%, mainly due to IFRS implementation, while risk metrics will be kept at sustainable levels.

Overall, the Consumer Durables segment operating profit increased by 13% year-on-year, contributed with 11% to the group's combined operating profits. This performance was driven by solid International revenues with pricing focus and rising domestic volumes despite contracting market. On the other hand, consolidated net income growth was stronger at 39%, mainly due to one-off FX and derivative gains.

Finally, let me also briefly talk about the Finance segment and the developments at Yapi Kredi on Slide 7. Yapi Kredi's net income was flat at TRY 1.24 billion, while pre-provision profit posted 40% year-on-year growth. Return on tangible equity was realized as 13.3%, while the bank applied a conservative approach in terms of cost of risk.

Cost growth was below inflation year-on-year at 18%, thanks to cost discipline, while revenue growth was 32% year-on-year on wider cost spreads and strong fee growth. There was almost 4 percentage points decline year-on-year on cost/income ratio, but a slight increase compared to fourth quarter of 2018 due to the impact in CPI linkers in first quarter of 2019.

In first quarter 2019, loan growth was 4% and supported by TRY 6.9 billion credit guarantee funds utilization. Deposit growth was aligned at 4%, whereby the bank gained market share in value-added segments, such as TL small ticket and demand deposits.

NPL ratio was almost stable at 5.4%, supported by NPL sales. Total coverage ratio increased further to 6%, which remains the highest level among peers and reflects Yapi Kredi Bank's conservative approach.

In terms of capital, the bank undertook 2 important initiatives, including a $4.1 billion capital increase in June of last year and an AT1 issuance of $650 million in January of 2019. Following these transactions, capital adequacy ratio and Tier 1 ratio are at 15% and 12.1%, respectively, comfortably above minimum requirements with above rough 200 to 250 basis points.

YKB has confirmed its full year guidance. Accordingly, in 2019, the bank expects around 15% TL loan growth and midteens deposit growth. In terms of profitability, the bank expects return on tangible equity at low teens, incorporating flat margin, solid fee growth, below average inflation cost growth and cost of risk below 300 basis points with continuation of its prudent risk appetite.

Overall, the Finance segment operating profit and consolidated net income were flattish year-on-year. In terms of shares in total combined operating profit and consolidated net income, it has the highest contribution among our sectors with 38% and 59%, respectively.

If we move to Slide 8, we can talk about the overall results of the group incorporating all of the segment trends we just discussed. On a combined basis, Koç Group registered TRY 75 billion in revenues; TRY 4.2 billion in operating profit; and TRY 2 billion in net income. Consolidated net income amounted to TRY 779 million with 32% year-on-year decrease.

However, excluding energy segment, which was impacted by the Residuum Upgrade Project maintenance and sharp FX losses incurred in March that will be recovered via natural hedge mechanism in the coming quarter as always the one-off gains of Otokoç in 2018 that I explained earlier, our consolidated net income growth would be 4%.

On Slide 9, we can see the breakdown of the consolidated net income performance. The biggest contributor was finance, followed by the auto segment. Energy segment, on the other hand, contributed negatively due to the impact at Tüpras that we mentioned earlier.

I would like to wrap up our presentation on Slide 10. In summary, we recorded a sustainable performance in the first quarter of 2019, mainly thanks to our diversified portfolio structure and our disciplined risk policy. We completed important capital market transactions, such as YKB's AT1 and also Koç Holding's proactive eurobond issuance. These enhanced our balance sheet strength, ensuring resilience against market volatility. Our resilience is also supported by our FX and FX-linked revenues, which make up around 55% of our combined revenues, including Tüpras. Value creation, extending our global footprint and diversifying our businesses further are always key priorities for us.

We take solid steps towards these targets. Tüpras started residuum upgrade maintenance to be ready for IMO 2020. Aygaz will team up with the United group and Arçelik acquired Singer in Bangladesh. Tofas will undertake a facelift investment for Egea/Tipo passenger cars starting from 2020, and Ford's custom plug-in hybrid derivative of Transit Custom will be launched in the fourth quarter of 2019.

Going forward, we have the potential to further diversify our positioning both domestically and internationally through our investments, while maintaining a sustainable and efficient level of liquidity.

This concludes my part of this presentation. I'd now like to turn the microphone to the operator for any questions.

[Operator]

[Operator Instructions] Ladies and gentlemen, there are no questions. I will now turn the conference over to management for any closing comments. Thank you.

[Gizem Bodur, executive]

Okay. Thank you for joining us this evening again. So hopefully, we will see you in August when we are announcing our second quarter results. Thank you. Bye-bye.

[Operator]

Ladies and gentlemen, the conference has now concluded. And you may disconnect your telephone. Thank you for calling, and have a pleasant evening.