Trip report: Turkey

On a visit to Turkey in November last year, the country’s political backdrop was showing clear signs of increasing tension, with President Erdogan’s attempts to maintain his tight grip having recently been challenged, highlighted by the defeat of his AK Parti in the Istanbul June 2019 mayoral elections.

Since the trip, the risks around the Turkish economy continue to be well-documented by the world’s financial press as the government and central bank have chosen to combat high levels of inflation with low real interest rates at the cost of dwindling foreign exchange reserves. 

As bottom-up investorsG1 we don’t claim to offer unique insights into the above, but due to these risks we would find many businesses in Turkey very difficult to invest in – a bank for instance, or a company with high levels of debt (local debtG2 but even more so, foreign debt), or a regulated business which might be asked to help control inflation through pricing. 

The most important thing for us is that we own companies prepared for a rainy day and which would not use economic dislocation as an opportunity to disadvantage minority/foreign shareholders. 

During the four-day trip, Chris Grey and I met with sixteen companies in total, dotting back and forth to either side of the Bosporus into Istanbul’s Asian and European districts. The standout meeting was with a company called Koç Holding1, our main, and in some cases, only exposure to Turkey in our client portfolios. 

Koç is a family-owned conglomerate, now run by the third generation. The company predominately is a hard currency earnerG3 with a large proportion of its revenues from the export market, sold in Euros, and a net-cash balance sheetG4

Its main businesses, most of which we met on our trip given they are listed in their own right and therefore have high levels of transparency, include two very long-standing joint ventures with Ford and Fiat respectively, where they manufacture, for example, most of the Ford Transit vans that are sold across Europe. Export sales for both companies are in excess of 70% (Ford 85%, Fiat 70%)2. They have historically benefited from a weaker Turkish Lira, boosting the competitiveness of their exports. 

The third Koç company we met with was a white goods company which has a significant export business (68% of sales most recently3), including the Beko brand, which might be familiar to those of you living in Europe. It too has enjoyed the weakening Lira when competing against products made in Europe and elsewhere. 

While Koç would prefer a strong and growing Turkish economy, critically, the family have for years set it up to prosper on rainy days. This is why we own it for clients. 

If we had to pick one non-financial piece of evidence that demonstrates the long-term conservatism of the Koç family, in sometimes trying economic times, it would be that they continue to own just over 70% of the company. We believe often families who take economic risks sometimes tend to find by the third generation that their stake has been diluted. Koç was founded in 1926.

We also met with Enka Inşaat ve Sanayi, the only other Turkish company we own shares in on behalf of our clients. Enka is another family-owned conglomerate, with one of the most impressive track records of conservatism and capital allocation in emerging markets.

Founded in 1957, the company’s substantial US$2bn net cash balance sheet, representing almost 40% of the market capG5 and 70% family ownership4, permit them to be incredibly discerning with regards to the projects they undertake. A luxury not afforded to most free-float /ownerless companiesG6

A good illustration of this is in the company’s construction and engineering operations (which today account for around a quarter of profits5) where they won a build-own-operate power plant contractG7 back in the late 1990s, in a joint venture alongside a US partner. At the time, Enka was one of very few groups to have the balance sheet and reputation to undertake such a significant project, resulting in a very generous contract, paying them a fixed amount of profit per annum for over fifteen years until the contract expired.

Today the company’s business interests are almost entirely outwith Turkey, with the largest portion of their US$2.8bn construction division’s project backlogG8 relating to projects contracted on behalf of the US government6. 

On the trip we also met with a handful of domestically focused companies, including a supermarket retailer with a capable management team, now owned, we believe, by a more risk-averse owner in the form of one of Turkey’s most established promoter groups, and a large opportunity set if they continue to execute. Whilst compelling, given the company’s debt coupled with the tricky operating environment, it remains a business for us to keep an eye on for the time being. 

In summary, Turkey like other emerging market economies, has it risks. Given the fragile economy and political backdrop, we are especially picky about the companies in which we invest. We continue to look for conservative owners and robust balance sheets with businesses well-positioned to prosper during the tough times, not just the good. 
 

James Fearon

September 2020

G1 Bottom-up: an investment philosophy which focuses on a company, rather than a country or sector.

G2 Local debt: debt in a country’s domestic currency as opposed to foreign debt which is in another currency, often US dollars.

G3 Hard currency earner: the income of a company is denominated in a currency which is regarded as lower risk such as US dollars or Euros.

G4 Net cash balance sheet: a company with cash reserves greater than liabilities.

G5 Market cap: the value of a company on the stock market.

G6 Free-float/ownerless companies: a company not owned by a family group with a broad range of shareholders.

G7 Build-own-operate power plant contract: a form of project delivery method. Usually for large-scale infrastructure projects, where a company receives a concession from the public sector to finance, design, construct, own, and operate a facility stated in the concession contract.

G8 Project backlog: future projects already won by a company.

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Footnotes

  1. The companies discussed herein are all the Turkish companies held by St Andrews Partners on behalf of clients as of 30 September 2020.

  2. Source: Investment team company research based on company 2019 annual reports.

  3. See footnote 2.

  4. Source: Market capitalisation data sourced from S&P Capital IQ as at 23 September 2020.

  5. Operating profit before tax.

  6. See footnote 2.