Emerging Markets series part 2: Koc Holding ADRs (US49989A1097) – the best of Turkey in one stock ?

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

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):

P/E 7,7
P/B 1.1
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:

Company Percentage Koc MV EUR mn P/E
Arcelik 40,5% 1.048,0 13,2
Tofas 37,6% 645,5 12,1
Turk Traktor 37,5% 366,7 10,6
aygaz 40,7% 334,6 12,2
Otokar 44,7% 173,4 12,3
Tat gida 43,7% 41,6 106,9
Marmaris 36,8% 7,7 62,0
Altinyunus 30,0% 6,8 282,8
Ford Oto 41,0% 912,7 10,6
Tupras 51,0% 1.623,6 8,1
Yapi Kredi Bank 41,4% 1.536,8 6,1
Yapi Koray 10,7% 1,5 #N/A N/A
Yapi Tipi 4,5% 1,4 #N/A N/A
       
Sum unlisted   602,56  
Net cash Holding   580,00  
       
Sum of part   7.882,81  
Market Cap Koc Holding   6.718,39  
“Discount”   14,8%

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.

Stock Price

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…..

Valuation:

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.

Summary:

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.

18 comments

  • Verstehe nicht, warum du nur Aktien die außerhalb der Türkei gehandelt werden in Betracht ziehen willst. Nach meiner Information haben ein paar deutsche Online-Broker in Istanbul einen Händler. Sicher weiß ich es von maxblue.

    Probleme sehe ich höchstens darin, dass Dividendenzahlungen nich auf ein Depot in Deutschland gebucht werden könnten. Dann muss man die Firma direkt anschreiben.

    • danke für den Hinweis. Ich ersuche, die Anzahl meiner Depots so klein wie möglich zu halten. Je mehr Depots desto mehr Zeit für Verwaltung und desto weniger Zeit für das Analysieren.

      2 Depots recihen völlig, am liebsten wäre mir eigentlich nur eines..

  • Shouldn’t the sum-of-parts valuation include holding company overhead? What is the holding company overhead? What is the tax burden on the holding company level on dividend income, or when they divest businesses? Many major Asian holding companies trade at 30-50% discount. Furthermore, a controlling majority shareholder always almost spells trouble for minority shareholders in the long run, in the shape of dilutions, a cheap buyout, or using the holding company as cash cow for unrelated purposes. The risk/reward profile is tilted against the minority investor. Past performance is not necessarily indicative of expected future results, but may be the product of the emerging economy and survivorship bias. Holding companies on average underperform relative to the market in the long run. Your analysis seems incomplete.

    • Dear Michael,

      if you would have bothered to read the full post you would have seen the part of the post where I did analyze this aspect extensively. I clearly stated why I think that Koc is a value adding HoldCo and why I would not apply a big discount to the sum of parts. If you have another opinion, fine, but don’t call this “incomplete”.

      mmi

  • My numbers were shareholders return (price change + dividends).

    I do not know where you got your infos. Total sharecount is relatively stable since 2008 (increase from 2.4 bn to 2.5 bn shares). Before, the sharecount increased for instance during a merger. I also don’t know where you got your EPS numbers from. Original TRY earnings per share are

    0,19
    0,22
    0,25
    0,23
    0,91
    0,77
    0,56
    0,68
    0,84
    0,92

    for 2003-2012.

    I guess your data source is somehow screwed up.

    • “I do not know where you got your infos. Total sharecount is relatively stable since 2008 (increase from 2.4 bn to 2.5 bn shares).”
      Original source, the yearly reports of Koc, http://www.koc.com.tr/en-us/investor-relations/financial-statements-and-statistics/annual-reports.
      I could have received he share number even more easy: http://www.koc.com.tr/en-us/investor-relations/stock-information-and-investor-tools/capital-increases
      The share number was quite stable since 2009, but it got strongly diluted in the years before. From 2003 (243 Mio shares) to 2009 (2.415 Mio shares) we see a dilution in factor 10. As the Nasdaq-traded ADR (KHOLY) is exchanged in 1:5 for turkish shares, I divided the share number by factor 5 to adjust the numbers for nasdaq-traded shares.

      As I am sceptical about the significance of EPS-development in an inflationary currency as TRY, I took the yearly reports to collect the total numbers of revenues and earnings in US-$.

      “I guess your data source is somehow screwed up.”
      I doubt it, I was searching at the source. 🙂
      I have to make small corrections for share number in 2006 and 2007 (the share numbers for that years differ even in different yearly reports), but they dont change the overall picture.

      • #Roger,

        Ok, I could not reconcile yor share numbers with the original ones and I stopped there.

        Interestingly you are referencing the original resource (http://www.koc.com.tr/en-us/investor-relations/stock-information-and-investor-tools/capital-increases) but you didn’t seem to have read it very thoroughly.

        This page is actually a very transparent overview when and how the share count increased. I think the important part to understand here is the column”bonus”. This is basically the stock split column. So the 100% bonus in 2002 is a very simple 2 for one stock split. I guess you know how a stock split works, is has nothing to do with dilution.

        There are 2 “real” capital increases in 2005 and 2007 which have been done via rights issues. Again, no problem here as rights issues grant the right for the existing shareholders to buy additional shares. I would assume that they were used to buy

        Finally, it seems that they have also issued new shares in the connection with M&A transactions. Overall one can calculate the “real” share increase over 15 years like this: 1,18 x 1,12 x 1,15×1,33×1,025 = 2,1. So they roughly doubled their sharecount over 15years which in my opnion is OK if one looks at the growth they have shown.

        Coming back to your numbers: I think the stock splits also explain your strange EPS nmbers. As you might know, you have to adjust your EPS numbers for ALL subsequent stock splits and bonus shares. My datasource fortunately does all those things automatically.

        I have to admit that I didn’t look at the Capital Increases page either s I had alrady fully adjusted numbers, but i think this is “Best in class” transaparency even for any “developed market” company and supports my view that Koc is a very transparent and profesionally managed conglomerate. Though in a very difficult environment.

        Maybe a final word: Yes, Warren and Charlie are really “hot” on “cannibals” but personally I prefer companies with real growth opportunities even if they have to issue new shares now and then to conservatively fund the growth. What I don’t like are companies which issue new shares to management via option programs.

      • Oh, perhaps mI totally misinterpretated the “bonus”-colum. I took it as bonus-shares for management or such that dilute the influence of “old” shareholders as it is known for lots of investment banks. I will give it a deeper look and search for informations about bonus shares for share holders in these years. Thank you!

        If you are right my doubts are fully unjustified. Of course my EPS-numbers are simply bullshit in that case and the over-all-picture of KOC improves extremely.

        On the one hand I do not have access to your database – on the other hand sometimes its worth to reinvestigate databases as they can be wrong. But a stupid interpreter – as I seem to have been – can make it even more wrong. 😉

        “Yes, Warren and Charlie are really “hot” on “cannibals” but personally I prefer companies with real growth opportunities even if they have to issue new shares now and then to conservatively fund the growth. What I don’t like are companies which issue new shares to management via option programs.”
        I couldn`t agree with you any more. I took the bonus segment for increases from management option programs.

  • Again you confirm your image as an excellent treasure hunter. Koc looks much more interesting with your analysis.
    You indicated the bad relation of the Koc-family and Erdogan. According to newly leaked telefone live recordings Erdogan seems to work very active against the KOC-Holding: http://www.spiegel.de/politik/ausland/erdogan-telefonmitschnitt-zu-ruestungs-deal-in-der-tuerkei-aufgetaucht-a-956970.html
    But perhaps these recordings may help to weaken Erdogan so much that he can’t hurt Koc anymore in the future.

    • thanks for the link. Yes I have read that story. Let’s wait and see how this one will turn out. There seems to be a lot of dirty laundry which has to be cleaned….

      • möglicherweise auch interessant.
        Zum ersten mal in der Historie der KOC Familie wird in einem Interview ein Premierminister kritisiert.
        KOC hatte sich bis dahin noch nie negativ oder positiv zur politischen Führung geäussert.
        http://uk.reuters.com/article/2014/03/02/uk-koc-turkey-idUKBREA210DO20140302

        Falls Erdogan die Wahlen Ende März gewinnen sollte (danach sieht es aus, da die “weniger” gebildete Schicht immernoch hinter Erdogan steht und dunkle Mächte für diese Situation verantwortlich macht) könnte es sehr interessante Einstiegskurse bei KOC geben bzw. Kurse zum weiteren Aufbau des Bestandes.

        In den Nachrichten werden jeden Tag die “Zinslobby” und die Parallelregierung für steigende Preise am Wochenmarkt verantwortlich gemacht. Das für das türkische Volk sensibelste Produkt “Brot” ist von 1 TL auf 1,25 TL gestiegen, nur wegen der “zinslobby” ! Erdogan nutzt die Situation sehr geschickt aus, um seine Anhänger gegen die Feinde von AKP zu mobilisieren.
        Daher wird vermutlich AKP die Wahlen gewinnen!

        Gruss

      • “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.”
        I suppose you spoke about growth of return?

        I added the company to my Excel-sheet and therefore checked sales and earnings as well as development of share numbers (adjusted for the ADR-level) for the years from 2005. (Fortunately Koc offers in its yearly reports also the nubers in US-$). And the picture got not as rosy as KOC likes to paint it.
        Year Revenue (Mio US$) Earnings (Mio US$) Shares (Mio, adj. for ADR)
        2005 34.511 2.081 253
        2006 34.377 392 266
        2007 39.515 1.764 313
        2008 42.964 1.565 402
        2009 28.984 924 483
        2010 35.865 1.156 483
        2011 44.876 1.272 483
        2012 47.327 1.291 507
        2013 34.809 1.409 507

        Year EPS ($)
        2005 8,2
        2006 1,5
        2007 5,6
        2008 3,9
        2009 1,9
        2010 2,4
        2011 2,6
        2012 2,5
        2013 2,8

        The growth is not very stable, but seems to be accompanied by a strong dilution of the share number.
        I did not check what happened in 2007-2009, but the raw numbers are not that nice. It might be misleading to start looking on revenue development in 2009, like KOC likes to do.

  • Hi mmi,
    you say that financials represent only 20% of the SOTP value (based on market valuations), but I’m sure you know that net income from financials in the KOC Holding represents 52% of total net income. Any thoughts on this? Aren’t you worried that financials might be severely impacted by an ongoing recession in Turkey?
    From a net income point of view, KOC is even more exposed to financials than the Turkey ETF you mentioned with 40% of exposure.

    • Hi Mixer,

      yes, financials are 50% of profits for 2013 (including the gain from the insurance sale), but still, in the sum of parts, Yapi is only around 20% of the total value as the are currently only valued at 6x P/E. So for the total valuation of KOc, I think the market value of the bank is relevant.

  • In D. wurde Koç durch die Übernahme von Grundig gekannt, was freilich weder für noch gegen sie spricht. Wenn ich aber auf EV/FCF schaue (FCF nahe Null) oder auf Schulden versus EK… Letzteres aber immerhin mit positivem Trend.
    Auffällig auch die Reduktion der Forderungen 2013. Hier würde ich nach den Gründen suchen. Wurde ein Teil der zuvor ao. hohen Forderungen verkauft?

    • Bilanzanalyse bei Koc ist auf konsolidierter Basis schwierig, da man ja eine Bank mit konsoldiert. D.h. alle konsolidierten Zahlen wie EV oder CF sind dadurch extrem verzerrt.

      Aus meiner Sicht macht hier nur eine Betrachtung der wesentlichen Töchter Sinn.

      Klar ist, dass man in den vergangenen Jahren stark investiert hat, für “free Cashflow Maschinen” soltle man sich besser in den USA umsehen…

      mmi

  • Thank you for this idea and the detailed analysis.
    Like you wrote it appears risky but may provide a good return, especially if several different stocks of this type are bought.

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