Still Nothing To Delight Turkcell Investors

Summary

• Turkcell had another good operating quarter, with further growth in postpaid subscribers, fiber/pay TV subscribers, and data/digital service utilization.
• Turkey remains a "basket case economy" in the eyes of many investors, undermining the currency and casting a shadow over Turkcell.
• "Guilt by association" may be unfair, but it's real, and it significantly mitigates the substantial undervaluation I see today in Turkcell's share price.

When I last wrote about Turkcell (NYSE:TKC) in late February, I wrote, “Turkcell still looks undervalued to me, but it also still looks like a potential value trap unless and until the situation in Turkey improves.” And so it goes, with ADRs down another 15% or so, as the Covid-19 outbreak has further sapped investor enthusiasm in emerging market stocks. If there’s a bright side, it’s that Turkcell’s performance over the last three months has been better than at least some emerging market names like America Movil (AMX), MTN Group (OTCPK:MTNOY), Telefonica (TEF), and Telkom (OTCPK:TLKGY), so … yay?

For better or worse, the Turkcell story remains as it was. Management has actually done a good job with respect to drivers like data and digital services, as well as growing fixed-line fiber and IPTV businesses. Overall, the company is shifting toward a richer service mix and one with fewer less-lucrative prepaid subscribers. Still, it’s an emerging market telco in an unpopular country during a risk-off phase of the market, so it’s going to take time before the stock’s apparent undervaluation makes any real difference.

Decent First Quarter Results

Turkcell managed to once again do a little better than expected on a quarterly basis, with revenue basically in line (Bloomberg consensus) and EBITDA about 2% better.

Revenue rose 17% year over year, and declined slightly on a sequential basis, with revenue in Turkey up 19%. Mobile revenue rose 19%, as 21.5% adjusted ARPU growth was offset by 2% subscriber shrinkage. Within the subscriber numbers, prepaid subs declined 19%, while postpaid rose 12%; management estimates it still holds strong 63% share in postpaid, with not much disruption from Vodafone (VOD) or Turk Telekom (OTC:TRKNY). Fixed-line revenue rose 17%, with solid growth in subs (fiber up almost 8%, IPTV up 18%) and good ARPU performance (up 13% for residential fiber). Segment-level EBITDA rose 27%, with the EBITDA margin expanding almost three points yoy and more than a point qoq.

International revenue rose 32% as measured in Turkish lira, with Ukraine up 38% (up 12% local) and Belarus up 11% (up 2% local). International EBTIDA rose 21% from the prior year, with margin down more than three points.

All-in, EBITDA rose 23% yoy and 2% qoq, with margin improving two points from the prior year and one point from the prior quarter on a richer revenue mix. Net debt came in at a very manageable TRY 10.3B (0.9x annualized first quarter EBITDA), and the company’s hedging position gives it a modest net-U.S. dollar position.

Covid-19 Will Create Some Challenges, But They’re Manageable

Unlike industrial companies, retailers, and consumer service providers, telco providers aren’t likely to see a significantly negative impact from the Covid-19 outbreak. If anything, people stuck at home are more likely to use their phones and pay TV more often.

There will be some negative impacts offsetting that, though, and management lowered its 2020 revenue growth outlook from 13% to 16% to 10% to 12% for 2020. The main negative developments are lower roaming charges (people not moving around as much), lower corporate income (businesses closed or seeing reduced activity), and lower consumer finance income, as consumer won’t be going out to buy new phones. Management has also elected to hold off on any further price increases during the outbreak – likely a very wise move from a consumer perception standpoint.

All in all, I don’t see many long-term problems coming from this, and there may be some positive developments. I believe reduced consumer activity (people staying home) could lead more subscribers to switch to postpaid plans, as going out to physical locations to top-up prepaid plans is not so appealing now. I also see users making more use of digital services and subscriptions that they may well decide to keep once the outbreak passes. With that, Turkcell likely still has ARPU growth potential in the near term even if there are no price increases.

The Outlook

The biggest negative change to my outlook concerns the dividend. The Turkish parliament passed a law a few weeks ago that limits Turkish companies to paying no more than 25% of their 2019 profits as dividends until September. With Turkcell having targeted a 50% to 80% payout ratio, that’s clearly a meaningful change, though it’s possible there could be opportunities to pay a larger dividend after September.

With a healthy balance sheet, no meaningful near-term maturities, and a good FCF outlook, I’m not worried about Turkcell’s solvency at all. That said, it’s a good house in a bad neighborhood; Turkey currency has been weak on low confidence/trust in the government, and I don’t see that improving anytime soon.

I still expect Turkcell to generate long-term revenue growth in the high single-digits, with a few more years of double-digit year-over-year revenue growth. Longer term, there are still meaningful opportunities to drive smartphone adoption/penetration, improved data utilization, greater digital product sales, and stronger adoption of fiber/IPTV. I expect increasing data and digital service consumption to continue to support higher margins and better cash flows, particularly as those services don’t require the same level of capex to support as traditional voice service. With that, I see FCF margins moving into the low double-digits, supporting a mid-teens FCF growth rate.

The Bottom Line

Turkcell shares look substantially undervalued, but that’s really a “so what?” call now. Turkey is untouchable to many investors, and Turkcell can only outperform sentiment on its home country just so far. I’d like to think there will be a point where Turkey gets a better government and where Turkcell’s qualities are better-appreciated by the market, but I cannot give you any assurance that that will happen anytime soon.

Analyst’s Disclosure: I am/we are long TKC, MTNOY. 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.