Koc Holding AS

IST:KCHOL.E

Earnings Call Transcript 2023-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I am Maria, your chorus call operator. Welcome, and thank you for joining the Koç Holding Conference Call and live webcast to present and discuss the second quarter 2023 financial results.

At this time, I would like to turn the conference over to Mrs. Cansev Atak, IR Manager at Koç Holdings. Mrs. Atak you may now proceed.

[Cansev Atak, executive]

Welcome, and thank you for joining us today. This is Cansev, IR Manager of Koç Holding. I have here with me our CFO, Polat Sen; IR Coordinator, Nursel; our finance coordinator, [Özge]; our IR Manager, Ismail to go over the presentation and answer your questions during the Q&A session.

I'd like to note that our presentation and the Q&A session might contain forward-looking statements and assumptions based on our business environment as we see it today, and they might be subject to change. please remember you can access the replay of the webcast on our website after the call.

Now I would like to hand over to Polat Sen to start the presentation. At the end of the presentation, we will have a Q&A session. Polat Sen?

[Polat Sen, executive]

Good evening, everyone. Welcome. I'll start with the presentation. On Slide 2, you can see today's agenda. And let's start with Slide 3 with some key indicators for Koç Holding.

I am proud to say that we had a solid first half year despite all the challenges. This year, global economic growth is expected to be lower than 2022, mainly due to the tight monetary policies, but still growth will be around historic leverage.

Now there is less concern for a global recession scenario. However, some of Turkey's main export markets will be affected by the slowdown in growth, especially in Europe. In terms of inflation, following the peak in '22, global inflation is falling, mainly driven by lower food and energy prices. In Turkey, despite the devastating earthquakes in early February, real economic activity remained relatively resilient and predominantly supported with strong domestic demand.

As Koç Holding, we have proven -- we have a proven track record in successfully managing volatility, as you all know. Our resilience, strong financials and intact fundamentals are the reflection of our diversified portfolio, agile management and prudent risk policies.

On the left, you can see the sectoral breakdown of our diversified business portfolio as of end of June. Here, the major change after the end of June is our lower effective ownership in Yapi Kredi Bank without loss of control. Following the 6.81% share sale to foreign institutional shareholders via accelerated book building.

As the transaction was closed on 28th of July, the Finance segment's lower share and higher share of our net cash in our portfolio is not reflected here.

On the right, you can see the revenue breakdown. Our portfolio diversification is not limited with sectors but also includes international positioning. We are the largest exporting group in Turkey with our exports accounting for around 7% of Turkey's total exports. In terms of composition of our own revenues on a combined basis, in the first half of 2023, 30% is coming from international sales. If we also include Tüpras, which is an FX-linked commodity business, approximately 50% of our revenues can be considered in hard currency.

Moving to Slide 5. You can see the evolution of our net cash in the first half of this year. At the end of last year, we had $74 million net cash position at holding level. For -- so far this year, our dividend income was solid and amounted approximately TRY 14.4 billion, excluding potential dividends for the remainder of the year from some of our companies as per our past year practices.

Considering our dividend income and other items such as management fees, operating and financial expenses and currency conversion impact, our net cash position at the end of June '23 has reached to $395 million, including Yapi Kredi AT-1 Investment. Meanwhile, incorporating cash inflow from the 6.8% share sale of Yapi Kredi Bank [ YKB ] in July, our net cash position becomes $645 million in total.

On Slide 6, you can see the main pillars of our solid balance sheet. As you all know, prudent management has always been a key focus area in Koç Holding. As we have discussed, our net cash position at the end of June stood at $395 million, including Yapi Kredi AT-1 investment, around 98% of our TRY 1.3 billion of gross cash is in hard currency.

At the holding stand-alone level, we like to keep some liquidity to service war chest against volatility as well as firepower in case of investment opportunities. In terms of funding at Koç level, the only debt we have is the $750 million Eurobond outstanding as of end of June. We strictly apply and regularly monitor our prudent risk management policies at each underlying company on a combined basis.

In terms of liquidity, leverage and foreign exchange position, we preserve and even improved our conservative levels. On a combined basis, our current ratio is 1.3x and our net financial debt to EBITDA, excluding the finance segment is at 0.5x. In terms of FX, we remain well within our risk management rules. I am very happy to share that our prudent management approach was validated by a recent rating upgrade.

On June 6, S&P has raised our long-term issuer credit rating from B to B+, applying the criteria exception that allowed us to be rated above transfer and convertibility assessment and Turkey's foreign currency, sovereign credit rating.

Accordingly, Koç Holding ratings are B+ in S&P, 1 notch above Turkey's sovereign rating and B3 at Moody's, which is flat to Turkish sovereign. As the largest investment holding company in Turkey and being active in diversified sectors, we manage our balance sheet to ensure that we always remain resilient against market volatility. Now I would like to hand over to Nursel to go through the other slides.

[Nursel Ilgen, executive]

Thank you, Polat Sen. Now I'll walk you through the sector development in the first half of the year. I'll start with Energy and Tüpras on Slide 8.

The Energy segment's contribution to Koç Holding's consolidated net income is sold in the first half, thanks to strong domestic demand, above average crack margins even with quarter-on-quarter softness in mid-distillates, wider differentials and easing energy costs despite lower capacity utilization.

The domestic demand for refined products was strong in the first 5 months of the year. Jet fuel sales surged 23%, Gasoline sales increased 24% and Diesel sales grew 5% year-on-year. In the first half, Tüpras domestic sales volume was up 4% and while international sales were down 22%, resulting in 2% lower total sales volume.

Looking at the refining margins, we see Med complex margin increased to $28.3 per barrel from $27.1 per barrel in the first half of last year. [Mid] diesel and gasoline margins remained below the previous year's levels, stemming from some softness in credit margins in the second quarter.

Accordingly, in the first 6 months to drive overall net refining margin amounted $9.6 per barrel compared to $13 per barrel during the same period of last year, mainly due to vehicle cracks and lower capacity utilization rate despite wider differentials and lower energy costs.

Tüpras capacity utilization rate was around 77% in the first half, mainly due to maintenances. On the LPG side, consumption was strong, increasing 28% year-on-year in the first 5 months of the year. Aygaz domestic retail sales volume was up 30% and including wholesale adverse contribution from Bangladesh, total sales volume growth was 46% in the first.

Let's move to Slide 9 and discuss the developments in the auto segment. Our auto companies sustained their strong performance in the first 6 months of the year. The segment contribution to consolidated net income was 22%. The main drivers of the stellar performance for robust domestic market performance, recovery in export markets, solid export contracts, OpEx control and pricing discipline. In the first half, we witnessed 55% surge in domestic auto sales, and our market share in the domestic market improved around 1 percentage points to 28% compared to the same period of previous year.

On the export side, the European PC market registered 18% gold, while commercial vehicle market realized around 14% increase, mainly due to last year's low base. Our group market share in the export decreased 8 percentage points to 37%. In the first half, Ford Otosan sales volume was 6% higher, while Tofas witnessed 53% decrease in export volumes due to expiry of [total] contract at 2022 year-end.

Strong domestic sales pricing discipline as well as currency tailwinds supported total revenues of fourth quarter Tofas. Export revenue growth was strong for quarter to some, including contribution of [indiscernible] , while it was down at Tofas, mainly due to discontinuation of top load production for export markets, as I mentioned before.

TürkTraktör, our tractor company, enjoyed strong domestic sales in the first half, mainly due to subsidized agricultural loans at lower interest rates and the company's export sales volume was also strong at 19% year-on-year goal. Otokar, our leading bus and defense company with superior R&D capabilities and prosperous products realized 75% growth in revenues. The share of international revenues cost around 59% of total revenues at Otokar.

On Slide 10, let's look at the consumer durable segment segment. The segment performance was supported by domestic revenues with currency payables for international revenues, including strength of euro against dollars as well as eased raw material and transportation costs. However, softening demand in main international markets and higher financial expenses were reflected on other margins.

The Turkish white goods unit sales increased 18% in the first half, while the export sales were weak and decreased 13%. Looking at Arçelik figures. In the first half, domestic revenues increased 84%, thanks to effective pricing and increase in unit sales. Similarly, international revenues contributing 62% of total increased 26% on the back of FX impact and inorganic growth despite a 4% decrease in like-for-like sales. Arçelik managed to attain the key risk metrics at healthy levels. The company's working capital to sales ratio was 24.4%, and leverage stated at comfortable levels with a net debt-to-EBITDA ratio of around 2.5x.

Finally, let me also briefly talk about the Finance segment and the developments at Yapi Kredi on Slide 11. The segment was the largest contributor to consolidated net income in the first half with the 43% share. According to BRSA financials, Yapi Kredi Bank's net income increased 26% to TRY 24.1 billion in the first half, while the return on tangible equity was realized at 36.8%. Due to a challenging operating environment, Turkish Lira loan yields were under pressure and funding costs were in an increasing trend. Yapi Kredi managed to preserve its loan to deposit spread in positive territory.

The bank recorded a substantially improvement in fee growth. The increase in operating cost was mainly due to HR business-related costs, also including inflation pass-through impact and also earthquake-related costs.

In the first half, total performing cash loan growth was around 21%, and total customer deposit growth was 35% year-to-date. The bank's strategy to focus on small tickets and deposits continued, and the share of demand deposits in total customer deposits remained at a high level with 42%.

The net cumulative cost of fees, including currency hedge was at 33 basis points, mainly due to strong collection performance and conservative coverage levels were preserved and the total coverage was 5.1% on a consolidated basis.

In terms of liquidity, Yapi Kredi also remains comfortable and the total liquidity coverage ratio of the bank stood at 161%. In terms of capital, Yapi Kredi continued to operate with around 500 basis points buffer on capital ratios compared to regulatory requirements, mainly supported by internal capital generation, Car and Tier 1 ratios stood at 17% and 15% by June end, respectively.

Now if we move to Slide 12, I'll walk you through the overall results of the group in the first half of the year, incorporating all of the segment trends we just discussed. On a combined basis, the Koç Group registered TRY 812 billion in revenue. TRY 83.7 billion in profit before tax and TRY 70.7 billion in net income. Consolidated net income amounted to TRY 37.4 billion, 69% year-on-year goal.

Moving on to Slide 13. You can see our second quarter only result with a net income totaling TRY 20.6 billion, implying 33% year-on-year growth.

On Slide 15, I would like to please talk about some of our unlisted companies. I'll start with Otokoç. That makes the largest contribution to our NAV among the unlisted assets. Otokoç is Turkey's leading auto retailing and car leasing company and #1 in second line sales. The strong appetite [indiscernible] continued to be supported for Otokoç. And as you may know, the company is Avis, Budget biggest licensee and its most important investment partner abroad.

So in the first half, Otokoç saw 141% year-on-year growth in total revenues, reaching TRY 36.4 billion and booked an EBITDA margin of around 19%. The book value more than doubled to TRY 13.6 billion in the first half, and this is almost more than double. Opet is the predistributor and has 19.7% market share in white products and 22.3% in Black products as of end of May, thanks to its well established dealer network. Opet operates with the goal of being the first choice of the consumer in the previous edition sector in Turkey through expanding station network.

Entek, the operational performance was impacted by lower hydrology in the first half of the year. And in line with Tüpras strategic transformation plan, the company aims to expand in the field of renewable energy not only in Turkey, but also abroad. Currently, around 75% of Entek's 442 megawatt total installed capacity is 0 carbon electricity.

Token Financial Technologies, Turkey's leading payment system platform provider. The company incorporated a payment and electronic model company in 2020 and receive the CBRT license in August 2022. Token controls business development activities also abroad via the company established in the Netherlands and Romania. Bilkom is one of the leading distributors of information and communication technologies, distributing products to -- products of leading global brands to over 4,000 different points. The company's revenues increased 12% year-on-year to reach TRY 9.2 billion.

I would like to briefly talk about WAT mobility established by our group companies named WAT, Opet, Otokoç and Entek. Well, WAT mobility, the tech company operates in the field of elective vehicle charging stations and the company has a target of rapid expansion throughout Turkey in terms of charging stations, which are of critical importance for electric vehicles.

Finally, another listed company, wholly owned by controlling is Koç Medical Bv. The company was established with the inspiration of the ventilators project [fulfilling] during the most challenging period of the COVID-19 pandemic. Koç Medical or Koç Yasa Çok Yasa, that's set out with the idea of producing solutions for health needs with a blend of technology. This company recently purchased shares of Bicakcilar, a medical device company providing disposable and therapy medical devices as well as operating room solutions. Now I would like to leave the floor to Polat Sen for concluding remarks.

[Polat Sen, executive]

Thank you, Nursel. On Slide 17, you will see the evolution of net asset value discounts our year-to-date BP average NAV discount is approximately 30% compared to the long-term average discount of 10% to 11%. At Koç Holdings, we benefit from our market proxy status and observed our NAV discount now narrowing down sharply in May this year, supported by sentiment and return of foreign investors.

Unfortunately, considering approximately 90% of our NAV is composed of our listed assets, the share price performance of the majority of our listed companies recently is not reflected to Koç Holdings share price. Besides the intrinsic value of our unlisted companies is much higher compared to their book values, which is obvious in an inflationary environment.

As discussed previously, Koç Holdings current discount level does not reflect its solid fundamentals, and we observed a deeply disconnected valuation. We hope to converge back to our historical NAV discount levels with enhanced liquidity, better sentiment as reflected by the decrease in Turkey's 5-year CDS levels, and a higher share of foreign real investors in free float.

In summary, our balance sheet is strong with a solid net cash position and potential cash inflow going forward. and our portfolio structure and diversification ensures resilience against volatility. As the leading investment holding company in Turkey, we are focusing on managing our portfolio dynamically. The recently announced transactions such as 68.8% share sale of Yapi Kredi Bank shares via ABB and Tat Gida's share sale process are a reflection of this.

We will continue to create value with our leading practices in the fields of environmental, social and governance. Value creation, extending our global footprint and diversifying our businesses further are always key priorities for us. We have the potential to further diversify our positioning both domestically and internationally through our investments while sustaining efficient level of liquidity.

Thank you for listening. Now we can open the floor for questions.

[Operator]

We have a question from one of our webcast participants, Samarth Agrawal with Citi and he has 3 questions.

The first, he wanted to understand the rationale for a partial stake sale in Yapi Kredi Bank. Number two, similarly for Tat Gida, any update around time lines for sale would be useful. And do you also have further realizations in pipeline for other assets? And three, could you remind us please on the companies which are expected to pay dividends in the second half of 2023?

[Polat Sen, executive]

Thank you. For the first question, for Yapi Kredi sale, the main intention was to crystallize some portion of our investments in Yapi Kredi. And we have seen some foreigners' interest in our shares. Another reason was to increase the free float and the liquidity of the bank. Remember, we have acquired 18% additional stake in Yapi Kredi back in April '22 with the consideration amount of $238 million at that size. You may view -- you may see that the share amount is similar to the share sale of the bought back shares.

So we continue -- we still continue to own the majority of the bank, and we continue to fully consolidate. We just have seen an opportunity to sell and materialize our profit on the shares that we bought 15 months ago. So that is the main rationale.

So for Tat Gida, your question, currently, we have a very strong balance sheet, very strong cash position. But at the same time, we are always looking to actively manage our portfolio. And we have initiated this project -- or process regarding the -- to look for possible strategic alternatives for Tat Gida. And we are looking for -- if there is a good opportunity, we should be -- as a portfolio company, we should be open to evaluate those. So the decision was mainly based on -- to see the alternatives there.

But I have to say that also any asset could be a candidate for a disposal as long as the price is right. We are an investment holding company, and our job is to ensure effective capital deployment. And also, we have to make sure that we are creating value for our shareholders. So that is one of the reasons why we have gone through a strategic alternative looking process for Tat Gida.

The third question is we want our companies to pay dividends, of course, as much as possible. But as of today, for the second half of the year, I think only Arçelik has some payments coming up, which is announced. The others are still looking at their cash position, and they haven't got any definite decision made for payment. So we will be waiting for their AGMs to get this decision. When the decision is done, I'm sure that you are going to be also getting the news. Thank you.

[Operator]

We have a question from our webcast participant Hanzade Kilickiran with JPMorgan and she says Polat Bey, Nursel, thank you very much for the presentation. One, you have accumulated significant amount of cash on the holding level post the sale of Yapi Kredi. How should we think about your capital allocation in the near term in terms of cash usage?

Number two, and can you please comment on your plans in the health care sector after the recent acquisition Biçakçilar? Separately, is it also possible to provide an update on battery production plans in Ankara? When do you expect the investment to start? And do you expect an imminent cash outflow related to this project?

[Polat Sen, executive]

Hanzade hanim, thank you very much. Surprising to see you on webcast rather than call. But of course, I'm going to be answering your questions. The -- yes, we have a significant amount of cash at holding level, but it is -- I want to remind that also we have paid back our Eurobond in the beginning of this year, which is $750 million. So the cash position of Koç Holding is very strong. But of course, we think that there may be opportunities in the market, and we need to be ready for any possible acquisitions in the future.

And of course, you need to have some equity reserves for anything coming up -- anything possible that is going to come up. So we think that this is -- the proceedings coming from Yapi Kredi sale is also going to be -- there's no exact place that we have reserved its money for. But of course, the portfolio activity is always a focus area for us.

So you can assume that these proceedings from this one or the other one in the future is going to be used in future businesses. And we have been active, as Nursel has explained. We have just acquired a health care company, and this is an area that we have been looking for, for some time. There may be some opportunities in the future, and we want to be ready when the time comes. But I have to underline that there is nothing right now as of today as a target for acquisition. We are just looking for opportunities.

The second question was about -- yes, I found it. On the health care sector, as I just mentioned, actually, it's an important business area that we are looking for. Especially after COVID-19, the efforts that we have done for ventilator, we have seen that our abilities, the R&D infrastructure that we have is able to really do something in this area and Biçakçilar acquisition is going to be kind of a basis for this health care business.

We think that there may be -- we are not talking about high-tech medical devices. Low to mid-tech medical devices are the first area that we have been looking for. And we think that this could be a very good basis to really grow this business with our extensive network that we have.

And the third question was about battery production. And I can tell you that the MoU was signed between Ford Motor Company, LG Energy Solutions and Koç Holding. And we have been working on a contract signing and joint venture agreement for some time. We are approaching to the end of these efforts, hopefully. The teams are really working and it's working through a positive direction. But I can tell that this is going to be a 25 gigawatt -- the first phase of this investment is going to be 25 gigawatt hours.

And when you look at -- I mean in terms of CapEx, we cannot provide any figure, but we are still working on the business plan, but still as a rule of thumb, considering the other battery cell investments worldwide, it would be fair to come up with a figure close to $2 billion to $2.5 billion CapEx in the first phase for the 25 gigawatt hours. So we have a minority -- we are going to have a minority in this project, most probably.

Therefore, we should be expecting to start spending money, I think, end of this year and start of next year. The first quarter of next year would be a better estimate, actually. Thank you.

[Operator]

There is a follow-up question from Ms. Kilickiran, and she would like to ask about Arçelik. It has been heavily penalized in Q2 due to lack of TL funding availability. Falling changes in CBRT and government's intention to support exporters, have you started to or hope to observe some improvement in TL funding on Arçelik side?

[Polat Sen, executive]

I think Arçelik has most probably answered this question -- will answer this question better. But what I can say is -- of course, the depreciation in Turkish lira has helped all the exporters and Arçelik is starting to enjoy it. The second thing is that -- and the second issue is the parity between U.S. dollar and euro, that is also a positive impact, which is 1.10 at this point. But, in terms of TL funding on the Central Bank and government regulations, let me say, is still -- I don't see any easing for Arçelik. So there's still much to be done at that point. So that's not helping yet. There are positive and negatives. Thank you.

[Operator]

The next webcast question is from Cenk Orcan with HSBC and he would like to ask the following.

We see slight quarter-on-quarter improvement in your solo net cash position. Is there a targeted level for YE '23? After the YKB stake sale very recently, what are the possible major cash generating and consuming items at parent level going forward?

[Polat Sen, executive]

What I can say is the first question is very much related to the dividend that we are going to be getting until the end of the year. As I told you, some of our companies are looking at their situation if there is a possibility to distribute some more dividends until the end of the year. So it's really hard to say as of today, there is a targeted level because that's going to be their decision.

So after the Yapi Kredi sale, as I've just explained, actually, it's a pool that we have in terms of cash we have today. Of course, we have been looking for, and we want to be more active in the possibilities of new investments. So we are looking for any targets that may really suit our strategic needs.

So therefore, there's no active process that's going on as of today. But in terms of usage of this money, yes, of course, we have some strategic plans and we are looking for opportunities. If we can really find the right target, we would like to have the enough amount of equity in our balance sheet so that we can get this done quickly. So this is all I can say. Thank you.

[Operator]

There is a second question from Cenk Orcan and he would like to ask, could you provide your domestic consumption outlook for the rest of 2023 and 2024? And would you expect a slowdown or contraction for discretionary products and credit demand in 2024?

[Polat Sen, executive]

Nursel is going to be answering that one.

[Nursel Ilgen, executive]

Okay. Yes. Consumer demand was very strong in the first half of this year. And actually, the growth figures were even better than our expectations for some sectors and our companies, especially in auto interactive consumer durable sectors, they revised their guidance upwards while export performance was mixed. But looking at our company's 2023 guidance, it would be fair to say that the second half of the year is going to be slightly lower compared to the first half. But as I said, the first half turned now to be much better than initial expectations. Regarding 2024, it's early to provide any guidance at this stage.

[Operator]

There is also a third question from the same participant and he would like ask the following. Have you observed any improvement in access to TRY liquidity after elections? Which group companies are impacted the most from tighter conditions and how do they deal with it?

[Polat Sen, executive]

We have lots of companies, but I can say that some of them are impacted more. The ones who are in need of Turkish lira, like I just explained, Arçelik is one of them. So other than that, we do not have any heavily affected companies, maybe some smaller companies, but it is doable. The Turkish lira liquidity -- the access to Turkish lira liquidity after election is something that is starting to -- we see some start in terms of signs that is improving, but this still seems like not enough yet. I'm sure that we are going to be hopefully seeing some more positive improvements in terms of Turkish lira liquidity. But at least seeing some positive movement is also a relief on our side. Okay. Thank you.

[Operator]

The next question is from Kamer Külek with Perform Portföy. And he asks, we haven't heard any news about a big new tender from Otokar for a long time. What would you like to say about this topic?

[Polat Sen, executive]

Otokar's business is like that, first of all, I mean, it's not -- it's a contract business. Of course, the macroeconomic activity in all over the world has also been affecting this situation. But what I can say about Otokar is it's a bus and defense company. The -- we -- they are doing a lot of innovations and firsts in Turkey, mainly focusing on R&D.

And they are very successful in a lot of regions, mainly Middle East, Gulf, Africa, Eastern Europe and Asia-Pacific regions. The company has subsidiaries in 4 countries; France, UAE, Romania and Kazakhstan, and exports to over 50 countries. So I think it would be fair to say that Otokar always focuses on improving its activities in export markets while with its existing R&D facilities and engineering capabilities.

So I'm sure whenever we see some contracts won, you're going to see the effect. And they are working on a lot of projects while we're speaking.

[Operator]

The next question is a follow-up question from Samarth Agrawal with Citi. And he asks, what are the IRR targets you look at for new investments? And which sectors are currently looking for new investment opportunities?

[Polat Sen, executive]

We generally target mid-teens in USD terms, and that may also, of course, differ from sector to sector or country to country. And I've already answered the new investment opportunity sectors, which is health care, renewable energy, that kind of areas. But we are not limited to those only. We are looking at lots of areas. Thank you.

[Operator]

Ladies and gentlemen, there are no further questions at this time. I'll now turn the conference back over to management for any closing comments.

[Polat Sen, executive]

I would like to thank everybody who have joined the call. I hope that was explanatory enough. And I also hope and expect our great performance to continue until the end of this year as well. And if you have any more detailed questions, our IR team is always at your service. Please feel free to contact with them. Thank you very much.