Turk Telekomunikasyon AS

IST:TTKOM.E

Earnings Call Transcript 2022-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Kostantinos, your Chorus Call operator. Welcome, and thank you for joining the Turk Telekom conference call and live webcast to present and discuss the third quarter 2022 financial and operational results. [Operator Instructions] And that conference is being recorded. [Operator Instructions]

We are here with the management team, and today's speakers are our CEO, Umit Onal; and CFO, Kaan Aktan. Before starting, I kindly remind you to review the disclaimer on the earnings presentation.

Now I would like to turn the conference over to Mr. Umit Onal, CEO. Sir, you may now proceed.

[Ümit Önal, executive]

Hello, everyone. Welcome to our third quarter results conference call. Thank you for joining us today. The heavy weight issues on the global agenda remained mostly unchanged from the second quarter. While the inflation, tightening and recession debates went on, a deepened energy crisis ahead has become a bigger fear factor. On the bright side, the spread of COVID-19 has been least talked about since the breakout of the pandemic back in 2019.

Continued tightening by large central banks pushed global interest rates higher, while the CBT pursued further rate cuts. An 8% average increase in FX rates Q-on-Q added to cost pressures.

Consumer sentiment, helped by the broad-based salary increases in July, as well as the holiday spree that prevailed throughout Q3, was better than the second quarter in certain aspects. However, inflationary pressures continued weighing on the consumer as the CPI exceeded 83% as of September.

On our side, a vibrant summer and tourism season benefited the mobile segment, while fixed broadband enjoyed the back-to-school period. Broadly speaking, operators' discipline on inflationary pricing in mobile remained unchanged with the third round of price revisions in the year introduced around mid-September.

On the fixed internet side, third quarter was more a period of rebalancing of prices in the aftermath of the wholesale tariffs revision introduced on 1st of June. Data usage picked up Q-on-Q in fixed broadband and stayed well above the pre-pandemic levels.

Mobile data consumption recorded a significant 13% growth year-on-year -- Q-on-Q to 13 gigabytes. Once again, we managed to deliver a balanced financial performance amidst macroeconomic difficulties. The upward momentum in ARPU and revenue growth confirm the accuracy and timeliness of our actions so far on both the pricing and base management fronts.

Starting with Slide #3 on our presentation, net subscriber additions. Total number of Turk Telekom subscribers reached 52.8 million, with more than 600,000 net subscribers increase in Q3 on healthy additions from both fixed broadband and mobile, in which the latter has been a bigger contributor.

Net subscriber additions were 1.4 million during the last 12 months. Fixed broadband subscribers rose to 14.8 million, with 214,000 of quarterly net additions following the slower performance in the first half, which was dominated by the post-pandemic normalization and pricing differences. Fiber subscribers reached 11.2 million. The share of fiber subscribers in our fixed broadband base surpassed 75% compared to 62% a year ago.

Mobile portfolio expanded to 25.3 million by adding 682,000 subscribers on a net basis, with the best performance in 15 quarters. Postpaid and prepaid segments grew by 322,000 and 360,000, respectively. Number of fixed voice subscribers declined by 274,000 during the quarter, in line with the strategy focusing on naked DSL sales in new acquisitions.

Slide #4, financial and operational overview. The quarterly upward trend in revenue growth continued over the third quarter with the accumulating impact of price revisions and the ongoing recontracting of the existing customer base. We expect a robust revenue trend in the remainder of the year, considering the pricing actions in effect in the third and fourth quarters.

Consolidated revenue grew by 45% year-on-year in Q3, while operational revenues recorded 43% increase. Subscriber growth, in addition to pricing, supported the 35% annual increase in fixed broadband revenue. Mobile revenue growth on the other hand, touched a new high of 49%, thanks to similar drivers fueled by stronger-than-expected seasonal factors.

Consolidated EBITDA grew by 17% year-on-year to TRY 5 billion, with an EBITDA margin around 40% lower, both Q-on-Q and year-on-year. Margin drivers were very similar to the second quarter, with continued pressure on costs. On the other hand, although lower Q-on-Q, the tax income partly offset the increase in net financial costs. Still, net income contracted by 43% from last year's high base. Net debt to EBITDA remained flat Q-on-Q at 1.54x, despite further FX volatility in the quarter.

Slide #5, fixed broadband performance. Pricing parities continued balancing out through Q3 in the fixed internet market, following our leading pricing actions, both in the wholesale and retail segments, starting from 1st of June. The impact of low seasonality and new price levels were visible on consumer behavior in July and August. But as usual, fixed internet sales gained momentum in September with back-to-school season.

As such, churn ratio followed a stable trend in the retail business, but picked up slightly in wholesale in quarterly comparison. Demand for higher speed packages remained robust, both in new acquisitions and recontracting. 24 megabits and above packages made as much as 63% of new acquisitions.

As a result, Q3 ARPA was 15% higher Q-on-Q. Upsell performance was also strong in heavy recontracting period, driven largely by the significantly high net subscriber additions of Q3 '20. Hence, annual ARPU growth moved up to 29% from 19% in the second quarter.

An important post-Q3 development to share is another round of retail price revision we introduced on 1st of October as part of our dynamic pricing strategy. This has been the third time we adjusted our retail tariffs since December 2021.

In addition, we launched the 12+12 month contract structure for the first time in our fixed internet business. It is still a 24-month binding contract, but it introduced a pre-agreed raise starting from the second 12-month period.

We now offer this contract to all our new and existing customers since 1st of October. In other words, we removed the 24-month flat fee offerings from our portfolio. The impact of our new strategy, both on the consumer and other ISPs behavior is yet to be seen. We built on our strength by continuously growing our fiber network. 57% of our subscribers are now on 24 megabits and above packages, compared to 53% a quarter ago and 40% a year ago.

Contribution from speed upsells will continue to be a robust and long-term driver of growth for our fixed internet business, we believe. We are highly motivated by bringing together our customers with quality connection, whilst we take pleasure in seeing our leading investments in this field pay back.

Moving on to mobile performance, Slide #6. Mobile market maintains its discipline on our inflationary pricing, but the real focus was on seasonality. Operators reached to grab a bigger share from a growing market, thanks to increased mobility and a robust tourism season in Turkey. Following the revisions in mid-June, both prepaid and postpaid price were readjusted around mid-September, whilst periodic promotional activities have remained part of the game.

MNP market continued contracting year-on-year but remained almost flat Q-on-Q as the ongoing widespread price revisions made it less meaningful for the consumers to move around. We maintained our top rank in net subscriber acquisitions in the MNP market for the fourth quarter in a row, with the highest net ports in the same period. Churn rate inched down both year-on-year and Q-on-Q and once again, hovered around historically low levels.

Net additions in postpaid and prepaid both surpassed our forecast, contributing similarly to overall base expansion. While postpaid made 66% of total mobile subscribers, our Prime base reached 5.6 million subscribers with some slight increase Q-on-Q. 34% and 52%, respective annual growth in postpaid and prepaid ARPU fueled the 40% surge in blended APRU. Successful ARPU management, alongside robust net additions of 1.4 million over the last 12 months, has driven annual revenue growth to 49% in mobile, ahead of our forecast.

Now let's take a look at the full year outlook on Slide #7. The 9 months top line and EBITDA performance urges another revision to our 2022 guidance. We now expect operating revenues to grow 37% year-on-year, EBITDA to be TRY 19 billion and CapEx to be TRY 14 billion. While the change in top line and EBITDA outlook can largely be attributable to pricing and better operational KPIs, the incremental CapEx reflects the impact of continued weakness in lira and our decision to accelerate Q4 investments in sync with a vigorous subscriber and usage growth.

Our ongoing actions have started bearing fruits and pleasingly, resulted in visible improvement in third quarter growth figures. It is early to say the challenges are behind us, but we progress in the right direction. We keep aiming for balanced growth with careful management of risks. Our trusting customers, high-quality human capital and superior technology are by far the richest resources we own to succeed in our goals.

Now I will hand over the call to Kaan to discuss our financial performance in detail. Thank you.

[Kaan Aktan, executive]

Thank you very much. Good afternoon. We are now on Slide 9 with financial performance. Our consolidated revenue growth in this quarter is 45%, which is visibly higher than the 31% recorded in the second quarter. In line with our expectations, growth trends in ARPU continues both for fixed broadband and mobile, which is through dynamic pricing and upsell focus. The superior net subscriber performance quarter-over-quarter also helped fuel an accelerated top line growth.

Fixed broadband revenue growth is now 35% compared to 26% in the last quarter, with almost half of the gains driven by the retail side. The split of net adds amongst wholesale and retail segment was much more balanced compared to any quarter since the third quarter of last year, owing to the elimination of price differences in the market as the other ISPs, sooner or later, followed our lead in pricing.

Obviously, back-to-school sales and consumers' gradual adaptation to higher pricing levels also helped. The newly introduced 12+12 month contract structure should accelerate the repricing of the existing subscriber base in an inflationary environment and support ARPU growth in the coming quarters. We also see now similar tools being used by other ISPs in the form of 6+6 or 12+12 or even the 3+21 type of structures.

Enjoying a lively demand, mobile delivered its best quarterly performance so far with 49% revenue increase. Strong prepaid additions were largely driven by visiting foreign tourists and Turks, who live abroad, but postpaid additions have also supported subscriber growth with similarly robust contribution.

Number of additional data package sales reached a historic level of -- historic levels. Historic high and over bundle revenues contributed significantly, both owing to high demand, driven by seasonal factors and widespread mobility.

Once again, the upcoming inflation data will continue shaping operators' pricing and subscriber base management strategies in the remainder part of the year. It's typical for the mobile sector to intensify competition on subscriber acquisitions in the last quarter of each year, but it's yet to be seen how this trend will play out in a high inflation environment.

Fixed voice revenue recorded 15% growth, with a stable subscriber base quarter-over-quarter. TV revenues expanded 23%, with a 27% growth in Home TV ARPU. Growth profiles of corporate data and other revenues were similar to the second quarter with respect to 25% and 86% increase. Equipment sales, ICT project and call center revenues remained as the primary drivers of other revenues. Finally, international revenue growth reached 68%, with traffic growth and currency impact.

We are now moving on to the next slide with operational performance. Consolidated EBITDA -- I'm sorry, we are still on Slide 9. Consolidated EBITDA is TRY 5 billion, with an EBITDA margin of 40%, down both annually and quarterly. While high base cost inflation and composition of revenue growth with higher contribution from relatively lower margin businesses led to the -- led the annual change, a broad-based salary increase effective from 1st of July and continued upward trend in network cost largely explained the quarterly evolution.

Excluding IFRIC 12 impact, EBITDA margin was 42%. In third quarter, operating expenses increased by 73% year-over-year to TRY 7.5 billion. Annual increase was 42% in the first quarter, 52% in the second quarter. The drivers of annual or quarterly changes in most OpEx items were very similar to those we have seen in the second quarter. Excluding the IFRIC 12 cost, growth in OpEx was 72% year-over-year.

Interconnection costs increased by 40% quarter-over-quarter, along with the quarterly pick up in TTI's traffic and currency impact. Tax expense increased by 44% year-over-year, in relation with fixed broadband and mobile revenue growth. Provision of doubtful receivables increased by 30% quarter-over-quarter, in line with our expectation for a pick up in the third quarter following a slower litigation activity in the second one.

Increase in cost of equipment and technology sales slowed to 58% year-over-year from 111% a quarter ago, which is along with the normalization in base effect as well as some normalization in quarterly project revenues generated by Turk Telekom and its subsidiary, Innova.

Other direct costs increased by 72% year-over-year and 24% quarter-over-quarter, with very similar drivers to the second quarter in which we had seen a pickup in commissions paid on prepaid loading, shared revenues and value-added services revenues.

Commercial cost increased by 70% year-over-year and 21% quarter-over-quarter, along with inflated customer care and marketing expenses. The network and technology expenses rose 98% year-over-year and 12% quarter-over-quarter, together with higher energy prices and cost of maintenance works in addition to weaker lira.

Personnel expense increased by 27% quarter-over-quarter, largely owing to the broad-based salary increase undertaken starting from July. The impact of fresh hirings in the second quarter for a newly acquired third-party project by our subsidiary, AssisTT, has also contributed to staff growth -- staff cost growth inorganically.

Our CapEx spending exceeded TRY 7 billion in the 9 months period, with more than TRY 3 billion spent in the third quarter. We upped our investment budget for the year to TRY 14 billion from TRY 13 billion earlier. We now project completing larger number of FTTH transformation projects as well as a higher number of overall Homepass addition within the last quarter when we compare it to earlier plans.

Base station additions, in order to meet additional capacity and coverage needs as well as mobile backhaul investments, are the other items to move the needle. Finally, the capitalized SAC cost should also increase slightly together with the larger-than-expected volume of subscriber additions.

Now let me come to the bottom line. Net income was TRY 1.2 billion, down year-over-year and quarter-over-quarter, along with another 8% average rise in FX rates. While higher net financial costs led annual decline, a lower tax income largely explain the quarterly change.

As implied by the FX sensitivity analysis reported in second quarter financials, we incurred additional FX losses in the third quarter. We continued supporting the hedge portfolio through short-term instruments, as a result of which we reported higher interest expense quarter-over-quarter. Consequently, net financial expense moved to TRY 2.6 billion from TRY 2.3 billion a quarter ago.

We are now moving on Slide 10 with debt profile. Net debt to EBITDA remained flat quarter-over-quarter at 1.54x despite further FX volatility in the quarter. Hard currency debt stayed on its declining trend. Cash and cash equivalents were TRY 5.8 billion, of which around 70% is FX based. This excludes TRY 5.3 billion of FX protected time deposit, a highly liquid asset that we book under financial investments according to the IFRS reporting rules.

The FX exposure included the USD equivalent of USD 2 billion of FX debt, USD 2.3 billion of total hedge position and more than USD 2 million of FX cash. As you can see on the bottom right chart, the hedged amount includes USD 260 million equivalent of FX-protected time deposit, which is up slightly from USD 240 million in the second quarter.

Net FX exposure was USD 450 million long position as of third quarter, but when we exclude the ineffective portion of the hedge portfolio, mainly the existing participating cross-currency swap contracts, the FX exposure was around USD 520 million short position. The share of local currency borrowings within the total debt portfolio remained flattish around 15%.

We are now on the Slide #11. The dynamics of the FX hedging market were very similar to second quarter with short-end functioning, but the long-end remaining rather illiquid. Hence, the cost of engaging in long-term hedging transactions was still away from meaningful levels. As a result, the short-term portion of our hedge portfolio increased while the net FX exposure contracted with continued decline in hard currency debt.

The FX sensitivity analysis we report regularly in our quarterly financial suggests, assuming all as constant, a 10% in increased FX rates would have slightly less than TRY 1 billion negative impact on our pretax income.

On the flip side, the sensitivity analysis produces around TRY 860 million positive impact in case of a similar appreciation in lira. Finally, the unlevered free cash flow continued its quarterly improvement and now reached TRY 2.2 billion.

This will conclude my presentation. I think we can now open up the Q&A session.

[Operator]

[Operator Instructions] I would like to inform you that Türk Telekom will have translation during the Q&A sessions. [Operator Instructions] The first question is from the line of Nagy, Nora with Erste Group.

[Nora Nagy, analyst]

I have two questions from my side, please. Firstly, on inflation in Turkey, what you've seen, again, a record high figure condition for last month. What's your plan about further price increase? Can we expect an acceleration verified for fixed broadband, too, not only for mobile? And then secondly, what's your outlook for energy expense in Q4?

[Ümit Önal, executive]

[Interpreted] Thank you very much. Allow me to answer your first question, and our CFO will answer your question regarding the energy prices.

The annual inflation exceeded -- reached 83% in September 2022, and the 12-month average inflation reached 60%. What I need to underline here is that with the dynamic actions we took, we increased the revenue growth from 25% in the first quarter to 31% in the second quarter and 45% in the third quarter in the face of rapidly increased inflation. During the last 1-year period, we have increased our prices 3x on the fixed broadband side and 4x on the mobile side.

On 1st of October, we have revised our retail fixed broadband prices, and we have also revised our contract structure at 12+12 month. Of course, we need to observe its effect on our subscribers. And we have revised our mobile prices in mid-September, the most recent one. We know that the last quarter is the one that intensifies the pricing actions, particularly related to subscriber acquisitions in the mobile market. So we have to see how it is going to be received under this high inflationary environment. Therefore, we are still evaluating if we can also make another price revision.

As far as the nature of our business, we have been following the inflation very closely and we are taking our position accordingly. And I would like to add a couple of words to clarify here. We know that the prices are very close on the mobile sectors -- mobile sites. And of course, like all the other operators, we are trying to avoid to take destructive actions and sometimes from time-to-time, even though we are the second operator, we take action in a leading position.

On the fixed broadband side as well, we are the leader operator here, and we have been increasing our prices. And we expect the competition to follow suit us closely. We don't see the same pricing appetite on fixed broadband side as it is in mobile.

[Kaan Aktan, executive]

Yes, for the part of the question that's related to energy costs, so obviously, when we say energy, it's mostly electricity for us. So there was another price adjustment at the beginning of September, which means only 1 month of the price difference went to our third quarter numbers.

So obviously, there will be some additional cost to come in the fourth quarter. That's one factor, but which is also important for us is what we will face when we enter next year. So if there are no further price adjustments in the earlier part of the year, we will start repeating a fairly higher base in terms of energy costs, and that will continue being the case for each quarter throughout the year. Was that clear?

[Operator]

[Operator Instructions] The next question is from the line of Demirtas, Cemal with Ata Invest.

[Cemal Demirtas, analyst]

Congratulations for good results. I would like to ask about the financing side. Most of the better-than-expected net income is attributed to deferred tax income. But you also have high financial expenses when we combine the FX hedging gain and interest expense together.

How should we think for the remainder of the year and in 2023, if we assume that the currency devaluation will be limited or any risk on that front? Because we are also in a high inflationary environment, we see that you are adapting to a changing situation. But already, although the currency didn't move very rapidly in third quarter, you have high FX expenses. So when do you think we are going to normalize in that sense? And how do you see the trends in the deferred tax income going forward?

[Kaan Aktan, executive]

Well, thank you very much for the question. So when we look at the quarterly financial income expense numbers throughout the year, so that -- I'm setting aside the impact coming from the FX rate fluctuations because we have a position there, and it's more predictable when you look at the loss in value of Turkish lira.

But what has developed throughout the year is we now see a higher financial cost coming from the hedge portfolio and also from the debt portfolio in the form of interest expense. Well, the first one is related -- again, both are related to the increased cost in lira funding.

Well, lira funding, obviously, there are different rates for different companies, for different tools because of the regulations. But for us, especially the cost of hedging and the use of short-term instruments for hedging, our currency position now started creating a higher cost.

And the other factor now we are using like 15% of our total debt is coming from lira instruments. We started also issuing lira bonds to local market for creating the lira funding. And that's also coming with a bit higher cost compared to prior quarters or compared to the cost of accessing lira in the prior quarters under different instruments like vanilla the commercial loans.

Now I think we should -- that part will definitely be related to the trend -- the future trend in lira interest expenses. If you don't assume any changes in that front, so I think the third quarter should be kind of -- should give a direction for the upcoming period.

We will try to expand the lira bond portfolio. That was something, I think, totally missing in the local market. I mean the blue-chip companies issuing lira bonds and now that's coming back maybe with reasons that we didn't expect to see. But still, I see it as a good progress. And there is demand for such product currently.

And obviously, the effects, as I mentioned, would be for the time being dependent on the devaluation of the Turkish lira going forward. Did I miss anything?

[Cemal Demirtas, analyst]

No. The deferred tax, I know it's harder to predict, but maybe there is a relation between your higher financial expenses and it's partially covered by the deferred tax income. So I want to understand the relation going forward. I know it's very difficult, but at least any indication on that?

[Kaan Aktan, executive]

Yes. Actually, what is more visible now in our P&L, I'm referring to the tax benefit. It's mostly coming from the revaluation of the fixed assets and tax incentives, like investment incentives. Obviously, since it's revaluation-based, actually, the revaluation number or the percentage will be the main driver going forward. So it's mainly dependent on the inflation rate, as you know. So if you see a higher inflation to stay, I think that will be more tax benefit to come from the revaluation of lira of the fixed assets.

[Operator]

[Operator Instructions] Ladies and gentlemen, there are no further questions at this time. I will now turn the conference over to Turk Telekom Management for any closing comments.

[Gulsen Ayaz, executive]

Thank you, everyone, for joining us today. We look forward to being with you the next time. Thank you. Have a nice day. Bye-bye.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may discount your telephone. Thank you for calling, and have a good afternoon.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]