Koç Holding A.S. (KCHOL) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. I'm Konstantinos, your Chorus Call operator. Welcome, and thank you for joining the Koç Holding conference call to present and discuss the full year 2019 financial results. At this time, I would like to turn the conference over to Ms. Sinem Baykalöz, IR Manager at Koç Holding. Ms. Baykalöz, may now proceed.

Thank you. Welcome, and thank you for joining us this evening. This is Sinem Baykalöz, IR Manager of Koç Holding. I have here with me our CFO, Mr. Ahmet Ashaboglu; our IR Coordinator, Nursel Ilgen; and our Finance Coordinator, Mr. Fatih Sertdemir, to go over the presentation and answer your questions during the Q&A session. 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 and our businesses as we see them today, and this might be subject to change. Before the call, we have sent out 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'll have a Q&A session, Mr. Ashaboglu, the floor is yours.

Thank you, Sinem. Welcome, and good evening. Let's start on Slide 2 of the presentation. At Koç Holding, our main aim is to ensure sustainability by deploying our capital in a diversified and value-generating manner. In 2019, we were able to manage volatility and proved our resilience one more time, mainly thanks to our diversified portfolio structure and our disciplined risk policies. In 2019, we had sustained dividend income to a large extent despite the volatile environment. Around 80% of our dividend income is derived from companies that have either FX or FX-linked revenues. The main components that ensure that this sustainability are, one, we have a sectorally diversified portfolio, which hedges us against sector-specific sensitivities and cyclicalities. No single sector represents more than 30% of our NAV. Number two, we are the largest exporting group in Turkey with our exports accounting for 9% of Turkey's total exports. In terms of the composition of our own revenues on a combined basis, 33% is coming from international sales. If we also include Tüpras to this number, which is an FX-linked commodity business, approximately 55% of our revenues can be considered not sensitive to the domestic economy. And finally, number three, we have leading positions in the sectors in which we operate. This allows us to maintain our strong pricing power. In this regard, we manage our balance sheet and investments to ensure that we always remain resilient. 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. As the largest company in Turkey and being active in many diversified sectors, we manage our balance sheet to ensure that we always remain resilient against market volatility. At the holding stand-alone level, we like to keep a certain level of cash to serve as a war chest as well as a firing power, should investment opportunities arise. As of the end of December 2019, our net cash position at the holding level was $433 million. As you know, in January 2019, we participated in the Yapi Kredi Bank's AT1 issuance with $200 million. Therefore, including YKB AT1 investment at fair value with accrued interest, our net cash reached $673 million. Please note that these figures do not include any cash outflow due to additional 9% stake share increase at YKB. Our gross cash is close to $2.7 billion and 77% of this position is kept in hard currency. In terms of our funding at Koç Holding level, we have 3 Eurobonds, including our latest Eurobond issuance of $750 million in March of 2019. The issuance allowed Koç Holding to prefund the Eurobond, totaling again $750 million redeeming in April of this year, 1 year in advance. The funds are mainly kept in short-term USD time deposits. We have no other debt obligations at Koç Holding stand-alone level. As a reminder, Koç Holding's ratings are BB- from S&P, 1 notch above Turkey's sovereign rating, and B1 from Moody's that is flat to Turkey's sovereign. We also have well-defined and prudent risk management policies that are regularly monitored both on a combined basis and 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 at 1.5x. In terms of FX, we have a policy of keeping natural position and we remain well within our risk management rules. As of December end, we are slightly long dollars both at solo and consolidated basis. Going forward, we will continue to maintain the solidity of our balance sheet. Despite lack of dividends from Tüpras this year, given challenging market conditions for the refining sector and approximately $200 million cash outflow related with the acquisition of additional 9% stake at YKB, our cash position will be still solid, considering dividend income and payment from Koç Holding in the first half of the year. Now I would like to briefly summarize our 2019 performance, focusing on our main sectors. Let's start with Energy and Tüpras on Slide 4. The domestic demand for refined products picked up in the second half of the year. In the first 11 months of 2019, we saw 2% decrease in diesel sales volume compared to the same period of last year. On the other hand, jet fuel and gasoline were resilient and posted 7% and 3% growth, respectively. Tüpras domestic sales volume was down by 13% in 2019 while export volume increased by around 61%, leading to 2% lower total sales volume. When we look at the refining margins, we see $2.9 per barrel decline in the Med Complex margin to $1.7 per barrel due to lower gasoline cracks, especially in the first half, and depressed sulfur fuel oil crack margins in the second half due to IMO regulation in 2020. Tight Ural-Brent differential was another factor that compressed Med margin in 2019. On the other hand, Tüpras' net refining margin was $2 per barrel higher than Med Complex margins, mainly thanks to higher white product yield and better crude selection ability of the company. Tüpras' overall net refining margin amounted to $3.7 per barrel versus $9.3 per barrel during the same period of last year, mainly due to narrowed differentials, weaker crack margins and higher natural gas prices. Residuum Upgrade Project maintenance impact as well as limited inventory were the other factors. Tüpras operated with 98% capacity utilization rate. And this is based on 30 million tons for 2019, despite the Residuum Upgrade Project's maintenance, which started on February 26 and was completed on May 13, nearly 2 weeks ahead of schedule. Although this maintenance had a negative impact of around $100 million in the first half of the year, Tüpras is fully positioned to take advantage of the IMO 2020 regulation change. In terms of expectations, for 2020, the Med Complex margin is forecast to be at $1.5 to $2.5 per barrel while Tüpras' net refining margin is expected to be $4.5 to $5.5 per barrel. Capacity utilization will be around 95% to 100%. And Tüpras announced refining-related CapEx guidance of $200 million in 2020. On the LPG side, consumption was almost the same in the first 11 months of 2019. Aygaz, the leading player in the LPG sector, focused on profitability and its sales volume grew by 3% year-on-year with 10% increase in exports. For 2020, Aygaz expects 2% to 3% contraction in sector volumes while for its market share is expected to be similar. Accordingly, looking at the Energy segment contribution to Koç Holding, we can see that its share in combined operating profit and consolidated net income are 27% and 8%, respectively. Net income contribution was impacted mainly due to narrow crude oil differentials, weaker crack margins, higher natural gas prices as well as the negative impact of planned Residuum Upgrade Project maintenance. Let's move to Slide 5 and discuss the developments in the auto segment. In 2019, Turkish automotive market realized 23% contraction. Yet we observed a recovery since September on the back of cheap loan campaigns by state banks that will remain in effect until the end of March 2020. In this period, our auto companies focused on profitability in the domestic market and managed to take advantage of some government incentives, especially Tofas with its Egea passenger car. Accordingly, our market share in the domestic market increased by 4 percentage points to 26%. On the export side, our group market share remained solid, especially supported the strong performance of Ford Otosan. During this period, Ford Otosan increased its export volume by 2% year-on-year, thanks to ongoing growth in the European CV market with Ford Europe's sustained leadership. Tofas, on the other hand, witnessed 20% decline in its export volumes, mainly due to weakness in passenger cars as well as ongoing shift in consumer preferences into SUVs and hybrid engines, in addition to the expiration of the Opel/Vauxhall contract in 2018. As you all know, more volumes than actual sales are guaranteed under the take-or-pay contracts. And therefore, impact of declining export volume on Tofas' profitability is limited. Total revenue performance of Ford Otosan and Tofas increased by 18% and 2%, respectively. International reviews were the main driver for both companies, supported by euro-based cost-plus contracts. These contracts allow our auto companies to remain resilient in periods of TL depreciation and domestic market slowdown. For both companies, international revenues contribute at around 70% to 85% to their total revenues. Regarding 2020 expectations, we expect more than 20% growth in the domestic market, pointing to 580,000 to 630,000 units for total auto sales. Ford Otosan expects its retail sales volume to be around 60,000 to 70,000 units while Tofas expects 78,000 to 84,000 units with lower market share compared to 2019 figure, mainly due to high base in passenger car segment, supported by government incentives. Regarding exports, Ford Otosan expects volumes to hover around 330,000 to 340,000 units, almost in line with 2019 figures. Tofas, on the other hand, expects around 7% volume contraction to 170,000 to 190,000 units, but the P&L impact will be limited, as I mentioned earlier, thanks to take-or-pay contracts, which are in excess of this figure. On the CapEx front, Tofas is targeting some increase from EUR 107 million in 2019 to around EUR 250 million in 2020, mainly related to Egea mid-cycle action as well as MCV and some for the new generation Doblo. Ford Otosan also expects CapEx to be higher compared to 2019 at EUR 180 million to EUR 200 million. Let's also touch upon our tractor company, TürkTraktör. In 2019, the farmers' sentiment deteriorated and demand was severely impacted by high input costs. During this time, TürkTraktör domestic sales volume declined by 38% year-on-year despite a recovery since August 2019. This was partly offset by strong export sales with 5% volume increase. Accordingly, TürkTraktör revenues decreased by 3%, mainly supported by price increases and currency impact. In 2020, the tractor market is expected to recover and grow in high-teens. Meanwhile, TürkTraktör is expecting higher increase in its sales volume with some market share gains while always maintaining focus on profitability. The company's export volume is expected to remain flat, maintaining the strong performance in 2019. Otokar, our leading bus and defense company, had a very successful year, thanks to its bus exports to Bucharest and Amman municipalities as well as 8x8 armored vehicle exports. These orders have been the results of superior R&D capabilities and successful products of Otokar. In this period, export revenues surged 78% to over TRY 1.9 billion, constituting 80% of total revenues. Overall, Otokar's net profit more than doubled in 2019 and reached TRY 352 million. In summary, we see solid performance from the Automotive segment of Koç Holding. Overall, the auto segment accounts for 33% of our combined operating profit and 39% of our consolidated net income. The auto segment's operating profit increased by 9% year-on-year despite the sharp decline in the domestic markets. The main drivers of this positive performance were solid international revenues and export contracts as well as cost discipline. Accordingly, our auto segment consolidated net income increased by 5% year-on-year. Excluding the one-off linked to the purchase gain on acquisition of car rental business in Greece by Otokoç in 2018, the auto segment realized a 15% year-on-year growth in consolidated net income. On Slide 6, let's take a look at the Consumer Durables segment. Last year, white goods sales in Turkey decreased by 6% due to weak private consumption. On the other hand, special consumption tax between November 2018 and June 2019 had a positive impact on the market. In international markets, both Western Europe and Eastern Europe recorded a slight increase of 3%. However, white goods exports in the sector was down by 1% year-on-year. Looking at Arçelik figures. Domestic revenues increased by 23%, thanks to underperformance of the market with a 6% year-on-year increase in unit sales. Arçelik realized significant market share gains in this period. On the international sales front, which constituted 68% of total, organic growth was slightly lower at 2% and revenues grew by 17%, mainly due to FX impact, supported by the acquisition of Singer in Bangladesh. In terms of profitability, strong sales programs and stable raw material prices were among the positives of the year. Looking at the key risk metrics. Arçelik managed to maintain them at sustainable levels. The company's working capital to sales ratio slightly improved, which stood at 27% on strong performance in terms of both receivables and inventory management. Leverage also stayed at comfortable levels with a net debt over EBITDA ratio of 2.4x. Approximately 20% to 25% of the existing debt will be rolled this year with lower interest rates. Regarding 2020 expectations, revenue growth is expected to be between 10% to 15% in TL terms, supported by both domestic and international markets. EBITDA margin expectation is around 10.5% while risk metrics will be kept at sustainable levels with less than 30% working capital to sales. Arçelik expects CapEx to be flattish compared to 2019 at EUR 200 million to EUR 250 million. Overall, the Consumer Durables segment combined operating profit increased by 8% year-on-year and contributed 13% to the group's combined operating profit. This performance was mainly driven by international revenues with pricing focus, supportive raw material prices and domestic volume growth despite contracting market. Finally, let me also briefly talk about the Finance segment and the developments at Yapi Kredi on Slide 7. Yapi Kredi's net income decreased by 20% to TRY 3.7 billion and return on tangible equity was realized at 9.8%. Lower-than-average inflation cost of growth and strong fee income supported this performance while the bank applied a conservative approach in terms of cost of risk. Volume growth was healthy with ongoing TL focus and NPL ratio increased by 2.1 percentage points year-on-year to reach 7.6%, impacted by the volatility in the operating environment. Total coverage ratio stood at 7.2%, which remains to be the highest level among peers and reflects YKB's conservative approach. In terms of capital, the bank undertook 2 important initiatives, including a TRY 4.1 billion capital increase in June of 2018 and an AT1 issuance of $650 million in January of 2019. Following these transactions as well as the internal capital generation, pro forma capital adequacy ratio and Tier 1 ratio are at 16.7% and 13.7%, respectively, comfortably above minimum requirements with a buffer of around -- or more than 400 basis points. In 2020, the bank expects high-teens TL loan growth. In terms of profitability, the bank expects return on tangible equity at mid- to low-teens, incorporating slightly widening net interest margin, high single-digit fee growth, mid-teens cost growth and cost of risk of around 225 basis points with continuation of its prudent risk appetite. Overall, the Finance segment operating profit decreased by 24% and the share in total combined operating profit was realized at 25%. In terms of consolidated net income, the total contribution became TRY 1.4 billion with 21% year-on-year decline. If we move to the 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 329 billion in revenues, TRY 18 billion in operating profit and TRY 10.8 billion in net income. Consolidated net income amounted to TRY 4.4 billion. On Slide 9, we can see the breakdown of the consolidated net income performance. The biggest contributors were auto and Finance segments, followed by others, Consumer Durables and Energy segments. I'd like to wrap up our presentation on Slide 10. In summary, we enjoyed the benefits of having a diversified portfolio structure and disciplined risk policies in a not-so-easy year like 2019. We strengthened our balance sheet via capital market transactions, such as YKB's AT1 and also Koç Holding's proactive Eurobond issuance. We took some important steps to extend our global footprint and to further diversify our businesses. Voltbek, Arçelik's JV with Tata Group's Voltas in India, started mass production in its greenfield refrigerator factory. Arçelik acquired Singer and Aygaz decided to team up with United Group in Bangladesh. Tüpras finalized Residuum Update Project maintenance to be ready for IMO 2020. Otokar established a subsidiary in Kazakhstan, Otokar Central Asia, as its third overseas investment. Tofas decided to undertake a facelift investment of Egea and Tipo passenger cars with the production of new versions expected to begin in fourth quarter of 2020. Mini cargo vehicle contract is extended for 3 years until the end of 2024. Ford Custom plug-in hybrid derivative of Transit Custom was launched in fourth quarter of 2019. YKB transaction is closed and we increased our share in YKB by another 9.02 percentage points. Going forward, we will continue to search for investment opportunities to further diversify our positioning both domestically and internationally while sustaining an efficient level of liquidity. Thank you for listening. Now we can open the floor for questions. Operator?

The first question comes from the line of Pamir, Koray with Unlu & Co.

Two questions at my end. First of all, any further color on your capital deployment plans, such as maybe potential renewable investments at -- in Entek and/or maybe a potential petchem investment at Tüpras? And secondly, given the lower dividend flow to you by your subsidiaries, should we expect higher dividend payout rates at the holding level in order to maintain a similar dividend payment compared to the previous years in TL terms?

Thank you, Koray, for the questions. On the capital deployment front, and specifically you asked about Entek and Tüpras, Entek is continuously scanning the marketplace for projects, for potential investments. As you know, that sector has gone through some difficulty. And there are a lot of assets up for sale at potentially quite attractive entry valuations. Of course, renewables is the main focus for Entek, and we -- as I said, we continue to look at those opportunities. And no decision has been made vis-à-vis any one investment at this point in time. But as I said, we will continue looking for opportunities. The Tüpras petrochemical question, we have not made a decision on that type of investment at Tüpras. Tüpras is currently undertaking certain evaluations for potential investments. And petchem, even though it's one of the topics that is being debated, it's not in the priority of the company. In terms of your second question about Koç Holding's dividend payment, obviously no decision has been made on that front currently. But looking at historically, Koç Holding has been distributing dividends at around 20% payout ratio and at around 2 to 2.5 percentage points in terms of dividend yield. I think it would be sensible to expect a similar dividend out of Koç Holding.