As this is a long post, a short summary in the beginning:
- despite the bad headline news, for me Turkey is one of the more attractive Emerging Markets, as valuations are moderate and most problems are clearly visible
- Koc Holding, the holding company of the KOC family offers an interesting opportunity to invest in a portfolio of Turkish companies with dominant market positions
- further, Koc Holding seems to be a professionally managed company with good capital allocation and very good long-term track record
- nevertheless, stand-alone the investment is clearly very risky at least in the short-term and should be part of a broader EM strategy
Turkey background: Lots of problems
Turkey is clearly the Emerging market country with the most obvious issues at the moment. The decline of the Lira triggered a massive interest increase by the Turkish National Bank, which clearly is not really a tailwind for the local economy. When people now speak about emerging markets, they usually distinguish between those who are still OK like China, Mexico and the Philippines and those who have problems (Turkey, Indonesia, India etc.).
Personally, in my experience in such situations, this distinction is most often wrong. Like in the beginning of the Euro crisis, when people for instance thought that Spain is OK, usually all countries in such a “bucket” have problems and the only difference is that the problems surface quicker in some countries than in the other.
That’s why I somehow like Turkey, the current problems are clearly on the table:
- Declining Turkish Lira
- Political issues with Erdogan/Gülen
- Protests and fights in Istanbul
- current account deficit
- war/conflicts in neighbouring countries
- Kurdish minority
- FX loans from companies
Expectations are low, you hardly find anyone who is positive, the consensus view is: “It will get much worse before it gets any better”.
Honestly, I do not have a magic crystal ball to look into the future, but experience shows that once the problems are on the table, the possibility of those issues already being priced in into the stock market are quite high.
From my point of view there are also a lot of positives for Turkey
- strategic well positioned between Europe and Middle East
- no resource course, people have to work in order to get richer
- young, growing population
- main beneficiary if political situation in neighbouring countries improves
- a depreciating currency automatically improves the competitive position. During the Euro crisis, almost everyone said it would be much easier for the “club Med” if they were not in the Euro.
Just as a reminder the map of Turkey and its “friendly neighbours”:
How to invest
There are clearly several aspects to consider. Corporate governance and shareholder rights in Turkey for sure are not at levels as in Anglo-Saxon or Northern European markets. Without a local account in Turkey, it is hard to trade Turkish stocks. So either one invests into a Turkey ETF, which has the disadvantage of a rather high banking exposure (~40 percent of the main indices) or one needs to focus on the stocks traded outside Turkey. To my knowledge, only 3 stocks are traded more or less liquid outside Turkey which are:
- Turkcell (largest Mobile operator)
- Anadolou Efes (Beer)
- KOC Holding, a conglomerate
As I am not so bullish on mobile carriers (see Whatsapp), and Anadolou Efes looked a little bit too hard for me after some merger activities, I looked a little bit more into Koc Holding.
Koc Holding is the Holding company of the Koc Family of various subsidiaries mostly operating in Turkey. The Koc family directly and indirectly controls ~78% of the shares, leaving a free float of only 22%.
The company looks relatively cheap, but we should not forget that interest rates in Turkey are at around 10% (at 8,10 TRY per share):
Div. Yield 2.3%
Market Cap ~ 7 bn EUR
The interesting thing about Koc is that almost all subsidiaries are listed subsidiaries. For some reason, a lot of the Koc companies are JVs with foreign companies where Koc “only” owns around 40%. I tried to compile the list of listed subsidiaries. Additionally, I added net cash at holding level and the non-listed companies at book in order to come up with a “sum of part” calculation:
||MV EUR mn
|Yapi Kredi Bank
|Net cash Holding
|Sum of part
|Market Cap Koc Holding
We can see, that around 86% of the total value is invested in observable, listed companies. Additionally, we can see that the “discount” is currently ~15% to the sum of part. This is not much compared to other holding companies, but we come to this later. Another important point is that financials (Yapi Bank) are only 20% of the overall value, so a lot less than in the Turkish stock index. The overall low P/E of Koc is clearly driven by Yapi Kredit and Tupras, also something which one should be aware of.
The major businesses:
Tupras is basically a refinery. Normally not a very attractive business, unless you are the ONLY refinery in a country. Tofas and Ford Oto are both car manufacturing JVs, Tofas with Fiat and Ford Oto of course with Ford. Together, they have around 20% market share in Turkey, but much more interesting, around 50% of the production is being exported. So they should make up a lot of lower domestic demand by exporting more.
Arcelik is a “white goods” household manufacturer (among others with the Beko brand) which has also significant export business. Turk tractor has 50% market share in tractors in Turkey plus a 50% export share. Yapi Kredi finally is Turkey’s 4th largest bank and a JV with Unicredit. It has average profitability compared to its peers.
All in all, Koc claims to generate 10% of Turkey’s GDP, which at least in my opinion is the highest concentration I am aware of in any country for a single Group.
So at a first glance, Koc Holding seems to be a very good way to invest into the Turkish economy with an underweight in financials and an overweight in market leading companies with a significant export share.
Qualitative assessment / other considerations:
When I looked into the 2012 annual report and also into the available investor information , I was genuinely surprised how good the material is.
Koc 2012 annual report is a must read for anyone interested in the Turkish economy although Koc clearly is subjectively maybe more optimistic. At the time of writing, Koc just issued their preliminary 2013 earnings and the results look surprisingly robust (+15% including gain on Insurance co sale, unchanged excluding)
In my opinion, Koc has many aspects which are lacking even in most developed markets companies:
- Clear targets: Grow above Turkish GDP and create shareholder value, IRR hurdle of 15%
- clear dividend policy (20% of Earnings)
- Some businesses profit from Lira weakness (50% of cars and tractors are exported, Beko white goods etc.)
I also liked how they explained their strategy: Expand into other sectors only in the home market, expand internationally only in sectors where they have significant experience int he home market
What kind of Holding company is Koc ?
I do think that Koc is actually a value adding Holdco. I make this subjective assessment on 3 major observations based on their excellent, regularly updated investor information :
First, they are not shying away from selling subsidiaries if the consider them as not good enough, such as the very well-timed sale of their insurance subsidiary at the peak in 2013 and several other subsidiaries in the last years
Secondly, especially for a Turkish company, I was very surprised how clearly they formulate their strategy. They have clear IRR target and also a clear strategy where and when to invest.
And thirdly, their track record is surprisingly good. Over the last 20 years, total return for Koc Holding was 33.8% p.a. in local currency. This translates into 7.9% p.a. in EUR or 8.6% in USD. It is slightly lower than the S&P 500 (9.5% USD) and DAX (8,4% EUR), but we need to consider that:
- Koc is currently trading 50% below their peak valuation in June 2013 (whereas both, DAX and S&P trade at all-time-highs
- in the last 20 years, Koc had to withstand, among other issues a hyperinflationary environment which culminated in a new currency in 2005 which had exactly 6 zeros less than the old one
For me, this is a quite convincing track record in generating and maintaining shareholder value in the long run. much better than anything I have seen in other “Club Med” countries.
Koc and Erdogan:
Following the protests in Istanbul, there were some stories that the Koc family took position against Erdogan. As a kind of revenge, then Erdogan sent special tax auditors to Tupras. However, as this very nuanced article points out, this could have been it already.
I am clearly no expert here, but the fact that the Koc family, among others, survived 3 military coups, the second world war and hyperinflation, the probability is maybe relatively high that they survive the current episode, but risks are clearly there.
Looking at the stock price, one has to look at the stock price in hard currency:
We are clearly not at the lowest level but still around -50% off the peak from June last year. Funny, how optimistic people seem to have been only 8 months ago…..
Koc currently trades at an P/E of around 7,7x 2013 earnings. Without the insurance sale, this would rather be like 9 times but still cheap.
In my opinion, under normal circumstances, a company like Koc with a lot of market leading subsidiaries and a great track record could trade easily at 10-15 times P/E. If we assume that the Lira will make back at least some of its decline (maybe 10-15%), we could see a potential upside without assuming any growth over 3 years 35%-100%. If we assume some growth, Koc could be more than a double, especially compared to current valuations elsewhere in Southern Europe.
In total, I think KoC Holding is clearly a risky but interesting stock in an interesting market. The combination of a good long term track record and a diversified group of well positiioned local companies reduces the individual risk to a certain extent, although the political issues between the Koc family and Erdogan have to be kept in mind.
At the current valuation, the upside is large enough so I do not need to try to time the market and will establish a 2.5% position in KOC Holding ADRs at current prices (USD 18,20 per ADR) for the portfolio.
Short term, the stock price could (and most likely will) go lower than the current level, when “risk off” mentality returns to the market.
A final warning: This stock is clearly more volatile than my average stock picks and should be seen as part of a more diversified “excursion” into Emerging markets. I plan to invest at least into 4-6 different EM companies with a total portfolio weight of 10-15%, the start was already made with a first Ashmore position earlier this week.
In parallel, I am also selling down most of my last Italian positions in order to derisk this part of the portfolio, as the valuations (and risk return relationships) for Italian stocks have become mediocre at best as people have become very optimistic.