Turkey's leading mobile services provider Turkcell (NYSE:TKC) has had a mixed performance run since my last update on the shares. Operationally, the company continues to do quite well, with relatively stable share in the mobile business despite aggressive pricing and ongoing growth in ancillary services. While the shares have risen more than 10%, they've lagged the broader Turkish market a bit, and I'd say the performance is relatively lackluster, given the heightened macro risk.
Although I still think Turkcell shares are undervalued, I likewise still think that macro issues tied to Turkey's economy and international relations loom large. I would also note that there seems to be some uncertainty in the market regarding the company's new strategic priorities regarding business and fintech growth - priorities that are going to demand investment spending. Turkcell pays a decent dividend, and its cash flow will likely support improved dividends from here, so at least, there's a "get paid to wait" argument in play for Turkcell shareholders.
Turkey's economy has looked a little better of late, but the numbers are still pretty mixed overall. Retail sales returned to growth, and there has been some stability in the currency, as stimulation efforts seem to be having some positive impact. Inflation had been pushed down into the single digits before a recent rebound into the low double-digits, but GDP growth remains weak (barely positive in the third quarter), and construction permits recently hit a 17-year low.
All told, though, the situation is still pretty fragile. The global economy appears to be slowing, and important markets for Turkey, like Germany, are not looking particularly healthy. On top of that, political issues are still looming large, as the U.S. has threatened sanctions tied to Turkey's decision to deploy the Russian S-400 missile defense system and in response to military action against the Kurds.
The impact of all of this on Turkcell is complicated. Operationally, there's not all that much risk, as Turks continue to use their phones (and make increasing use of higher-priced data services), though I suppose a weaker economy could limit growth of higher-value services in the near term. The bigger risk is to the currency and the perception of risk surrounding the stock and its local operating environment.
A change in management at Turkcell has not yet brought major changes in the business, but the new management team does have a different set of priorities for driving growth. While the prior team was focused on exiting non-core operations (like the Fintur sale), improving core mobile profitability, and building out ancillary services (fixed line broadband, pay TV, digital services, and e-commerce assets), the new team seems more focused on opportunities with business customers and fintech.
Turkcell's priorities on the business side still seem a little vague, but management has noted it holds only 5% share in the Turkish ICT market, and that it intends to build share by investing in data centers and service integration capabilities. While serving a growing demand for data center services in Turkey arguably makes some sense, management acknowledges that the growth it is targeting in business revenue will dilute margins.
Further investments in fintech make more sense in my view. Although mobile-based payment systems haven't really caught on in the U.S. yet, they're quite a bit more popular in markets where the banking system isn't as interested in the needs of small consumers. Turkcell's Paycell business is already generating 70%-plus EBITDA margins and outgrowing the legacy business in Turkey, and I think this is a reasonable place to reinvest for growth.
As opposed to the greater focus on business customers, I'd like to see Turkcell improve its position in broadband and digital services. Efforts like Bip instant messaging, Dergilik digital publishing, TV+ mobile TV, and the Yaani search engine have led to good growth and customer engagement, and I believe Turkcell could build more value for shareholders by focusing on more over-the-top services to leverage its relatively stable and happy (strong Net Promoter Scores) customer base.
Management has been using inflationary pricing to cope with the macro situation in Turkey, and the company reported 15% growth in revenue from its Turkey operations on a 17% improvement in mobile ARPU and nearly 20% increase in residential fiber ARPU. Subscriber counts have been fairly stable for the mobile business, while the company continues to add fiber and IPTV subs. Management expects this growth to continue - at its mid-November capital markets day, they guided to a 13% to 16% annual revenue growth rate through 2022 (or 3% to 5% in real terms).
Turkcell has also been improving its profitability. EBTIDA margin for the Turkey operations improved more than half a point (to over 42%), and management is guiding to a longer-term target of 39% to 42% (with some dilution likely from the increased focus on business customers). Profitability has also improved significantly in the company's small overseas operations (Ukraine and Belarus, mainly), while the consumer finance business has seen some increased headwinds of late from regulatory limits on consumer lending.
Although I don't agree with management's decision to prioritize business services as a growth driver, I do otherwise largely agree with the key priorities they laid out at that capital markets day - namely, pricing that keeps pace with inflation and reflects the value of the services provided, balance sheet risk management, strong FCF generation, and prudent capital allocation. Importantly, while it seems that Turkcell management is looking at opportunities to grow its service businesses outside of Turkey, it's not looking to acquire other mobile operators.
The biggest change in my expectations for Turkcell relative to my last update is a somewhat higher growth rate (boosted in part by more success than I expected in raising prices) and slightly lower margins as the company targets more revenue from business customers. As far as capex goes, though, the company seems content to stand pat with its "4.5G" approach and focus on increased utilization of its 4G network as opposed to a full-scale roll-out of 5G service.
Helped in part by inflationary pricing, but also strong underlying growth in areas like fintech services, I expect close to 10% long-term revenue growth from Turkcell and a relatively similar level of FCF growth.
Turkcell shares do still look undervalued, but I don't expect that to change soon, given the ongoing concerns investors have about Turkey's economy and government. I also believe Turkcell will have to convince investors over the next couple of years that its strategy of focusing on increased growth from business clients is a prudent one. All told, I think Turkcell may well continue to be a frustrating holding for value-oriented investors, though the prospect of improving dividends on strong FCF generation does mitigate that to some extent.
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Disclosure: I am/we are long TKC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.