TKC - Turkcell: Not A Turkish Delight

Summary

• Turkcell is one of the largest telecommunications provider in Turkey with a commanding position in mobile.
• The company saw 57% YoY growth in revenues in Q3/22.
• However, the strong operating performance is really a symptom of runaway inflation in Turkey, as the company's ARPU has not kept up with inflation and EBITDA margins shrink.

While conventional analysts look for reasons to buy a stock or fund, I usually start my analysis looking for red flags and reasons not to buy. The reason I do this is simple: I want to know and understand the bear case, because I want to protect against downside surprises. Far too many retail investors get caught up by fantastic growth forecasts and valuations and end up getting burned when the smallest deviation from their expectations cause a stock's value to crumble.

In the case of Turkcell Iletisim Hizmetleri A.S. ( TKC ), while the company's operations look fantastic, with 57% revenue growth in local currency, the growth is really a symptom of runaway inflation in Turkey more than anything else. On a longer-term basis, revenue per user is not keeping up with CPI inflation and margins are suffering. Until the country gets a handle on its inflation problem, I think investors should stay on the sidelines.

Brief Company Overview

Turkcell Iletisim Hizmetleri A.S. ("Turkcell") is one of the largest telecommunication providers in Turkey, with market leadership in mobile with 37.5 million subscribers and 99% coverage of the country. Turkcell is also a strong challenger in fixed-line broadband, with 2.8 million subscribers (Figure 1).

Turkey An Ideal Environment For Telecommunications

In theory, Turkey should be an ideal environment for telecommunication investments, as the country has a young (half of population is under 32) and tech-savvy population with rising digital adoption (Figure 2).

With its broad and diversified business lines, offering everything from telecom services to fintech payments, Turkcell appears well positioned to capitalize on the demographic tailwinds (Figure 3).

Operational Performance Soaring In 2022

Operationally, Turkcell appears to be firing on all cylinders, with Revenues, EBITDA, and Net Income soaring by 57%, 49% and 68% YoY in the latest Q3/2022 quarter (Figure 4).

With such strong operational performance, what is there not to like about Turkcell?

Turkish Lira Is The Main Problem

The main problem for Turkcell that I can see is the Turkish Lira. Or more precisely, the problem is that Turkey has an out of control inflation problem so soaring revenues at Turkcell is a 'symptom' of that problem, rather than something to be celebrated.

According to the Turkish Statistical Institute, Turkey's official inflation rate soared to 85% YoY in October 2022 (please note that the official inflation rate may be understated as the authoritarian Turkish President Recep Erdogan had fired officials in the past for producing figures he did not like), before declining to 58% in January 2023 due to base effects (Figure 5).

Soaring inflation have caused a collapse of the Turkish Lira, from less than 6 TKL to the U.S. dollar as recently as 2019 to over 18 TKL/USD recently (Figure 6).

Running On A Treadmill

Viewed from this context, Turkcell's 57% revenue growth becomes much less impressive. In fact, if we look at Turkcell's ARPU since 2019, it has underperformed CPI inflation (Figure 7).

Turkcell must constantly increase prices in order to run-in-place, due to the astronomical inflation rates. Despite EBITDA increasing 49% YoY, Turkcell's EBITDA margin actually declined, suggesting that operations have regressed (Figure 8).

Furthermore, if we look at Turkcell's balance sheet, we can see that despite 'strong' operational performance, the company's gross debt increased 109% YoY and net debt increased 77% YoY (Figure 9). What is going on?

The problem is that much of Turkcell's debt is denominated in foreign currency, so with a plunging Turkish Lira, Turkcell's debt actually got revalued much higher in 2022 (Figure 10).

Although Turkcell holds foreign currency and derivatives in order to try to offset the headwinds, it is unclear how effective this will be when the debt obligations actually come due (Figure 11).

Another important fact that investors should keep in mind is that in the telecommunications business, much of the equipment is manufactured and sold by global companies like Ericsson, Nokia, and Huawei, so Turkcell must spend 'hard' currency to upgrade its kit while earning depreciating Turkish Lira.

Risks To My Cautious View

Of course, a risk can also become an opportunity. If Turkey can stabilize its out of control inflation rate, then Turkcell and other Turkish businesses may be able to better plan their operations. However, that could still be far away, as Turkey recently 'lowered' its interest rates in a counter-intuitive move at the behest of President Erdogan.

Conclusion

Although Turkcell's operations look fantastic at first glance with 57% YoY revenue growth, the growth is really a symptom of rampant inflation in the Turkish economy that is threatening to blow up. Looking on a longer-term basis, Turkcell's ARPU have not kept up with inflation and its EBITDA margins are declining. Until the country gets a handle on its inflation problem, I think investors should stay on the sidelines.

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