The Week That Was in Turkey – Weathering the Perfect Storm
Carlos Hardenberg, Founding Partner & Portfolio Manager, MCP
01 November 2022
Istanbul, a city which never fails to impress with its rich history, culture and hospitality, didn’t fail to impress us this time either with its resilience in navigating challenging times. We visited Istanbul in October, and the city was still buzzing with tourists – bustling hotels, long queues for the tourist attractions and ringing cash registers at high-street retailers. Foreign currency is flowing into the country, at the markets and retailers, but what is most evident is the foreign currency investment in real estate. Istanbul, a city with 15.5 million people, appears to be bursting at its seams.
There is always more than meets the eye and the week we spent in Turkey brought us closer to reality – an economic crisis is looming in Turkey – extreme currency depreciation, high inflation and an unorthodox economic policy by the incumbent leadership that continues to cut interest rates. These aspects, combined with the political uncertainty as the country heads into elections next year, has made planning and forecasting difficult for most companies and economists we interacted with. But there are hidden gems for investors to discover.
The outcome of the 2023 elections is probably the most interesting and most discussed topic in Turkey. We met several companies across sectors including retail, technology, healthcare, energy, manufacturing, industrials and banking. We also met with politicians, pollsters, economists, and policymakers on our trip to gain insights into the trends and indicators regarding the polls, but there is still uncertainty and we walked away with a contrasting conclusion at the end of every meeting.
We wanted to assess the following:
- Macroeconomics and monetary policy in Turkey
- Health of banks and large and small corporates
- Consumer confidence
- Adaptability and outlook of our portfolio companies
The Macro:
- Depreciating currency: The Turkish lira has depreciated over 50% against the US dollar in the last year and is now at an all-time low. Concerns over inflation, the Russia-Ukraine war and economic instability are exacerbated by skyrocketing inflation and expansionary monetary policy. Managing FX risks has been one of the biggest worries for companies this year. It was interesting to see that even small businesses such as market vendors and taxi drivers preferred being paid in US dollars or euros over lira.
- High inflation: Recent headline inflation stands at 83%. This is the highest reported inflation rate since 1998. The real inflation across food and transport appears to be higher still, thus hurting consumers even more. This has led to an 80-100% wage increase across the board which in turn might create a wage-price spiral. Companies are resorting to wage increases to attract and retain talent as more and more employees are choosing to move to other parts of the world for careers in stable economies that pay in hard currency.
- Energy crisis: The increased oil and gas prices affecting most net importers are also hurting Turkey. The country’s energy import bill has doubled in the last year and is adding to the widening fiscal deficit. The government has increased energy imports from Russia at discounted rates and delayed payments to contain energy bills.
- Expansionary monetary policy: The Central Bank of Turkey believes that high borrowing costs lead to high inflation and has continued to cut lending rates. The interest rates are currently at 10.5% (vs. 14% at the start of the year) and the central bank has signaled further cuts to single-digit levels until inflation reaches 5%.
Winners: Exporters are benefitting from the weak currency and the low borrowing rates which provide them with a competitive edge over their Eastern European and Asian peers.
Losers: Banks are negatively impacted as they are unable to reduce their borrowing costs due to the requirement of buying fixed-rate government bonds. Importers, including retailers and FMCG companies with limited pricing power are hit by the depreciating currency.
We expect loosening monetary measures to continue in 2023 as Turkey heads into the elections. Lower interest rates will benefit small enterprises, which form a large proportion of the voter base. But this appears to be largely priced-in given the currency depreciation and near all-time low stock market valuations.
The Businesses:
- Banks: Despite the currency crisis and cutting interest rate regime, banks are in good health. They are adequately capitalised and NPL ratios are within reasonable levels. There is a desire to cap their lending activity. Banks are required to buy long-duration fixed-rate government bonds, thereby increasing their borrowing costs. FX-indexed deposit schemes that assure customers of a return equivalent to a fixed rate plus the rate of TRY depreciation are being offered to attract Turkish lira savings into the system.
- Large corporates: We met the two largest corporates in Turkey – Sabanci and KOC Holdings – to understand their outlook and measures taken to adapt their businesses to the rapidly changing economic environment. Increasing exposure to export business, improving technological and manufacturing efficiency through foreign collaborations, and rising investments in renewable energy are just some of the key strategic priorities for large corporates. It is heartening to see the excellent presentation and reporting of Turkish companies and the growing adoption of sustainable practices and reporting
- Small and medium-sized enterprises: These form the backbone of emerging economies. In Turkey, such enterprises are generally still in good health despite the mounting challenges they face. Their balance sheets remain robust with buoyant tourism and growing exports continuing to drive demand for their products and services.
Consumer Confidence:
It is interesting to see how consumer behavior has been adapting to sky-high inflation and macroeconomic uncertainty. We met with some of the largest retailers in Turkey who alluded to visible signs of customers downtrading (if the price of a loaf of bread increases every two weeks, who wouldn’t?) and parallel trading from corner shops to organised retailers. The recent efforts in increasing e-taxation have created a level playing field and organised retailers are able to offer products at competitive prices. But consumer discretionary spending is being affected as locals are buying less cars and houses. Although interest rates are being cut, there is a cap on LTVs that makes borrowing difficult.
Medical tourism in Turkey has become a major source of foreign currency revenue. The advanced medical technology and quality talent available at lower rates are attracting medical tourists, especially from Eastern Europe and the Middle East, for medical and cosmetic procedures. We visited a 27k sqm hospital run by a leading Turkish hospital chain specialising in stem cell treatments for medical tourists. This 160-bed tertiary care hospital looked nothing like a regular hospital. Designed by a leading Turkish architect, the interior of the hospital resembled a human cell! It also had some of the most sophisticated MRI machines and a list of accreditations from renowned medical institutions across the globe.
Our Portfolio:
We met with both our Turkish portfolio companies – Mavi, a leading jeans/apparel brand and Logo, an ERP solutions provider – and continue to believe in their growth.
MAVI – Mavi is a popular denim and jeans brand in Turkey founded in 1991 (we noticed people wearing their jeans and sweatshirts in the busiest neighborhoods in Istanbul). We met with the CEO, Cuneyt Yavuz and Duygu Inceoz – senior director of IR, at their offices. The headquarters are situated above a store and exude a casual atmosphere, with all employees, including the CEO and IR, wearing jeans.
Our discussions focused on rising costs and the brand’s appeal and defensibility in such circumstances. Mavi has a dominant market share in Turkey and its competitive positioning has strengthened over time. It has continued its exceptional growth even in the last year. Foreign competitors such as Zara, H&M are forced to stock limited SKUs due to currency uncertainty and given their EUR pricing strategy, they are becoming increasingly expensive for local customers. Mavi also has an edge over its local competitors due to its scale which has enabled the company to secure capacity with its suppliers at discounted rates and to manage supply chain disruptions. A lean balance sheet further helps the management to navigate the crisis.
Mavi has seen a 30-40% increase in customer traffic over the last year and continues to see real (volume) growth. Mavi leveraged its scale and low cost of production to launch adjacent brands in the US targeting new customer segments. As part of this strategy, they recently acquired a premium US brand that expands the offering beyond jeans. Mavi has very low exposure to Russia and intends to exit the market completely.
Mavi expects to grow at >100% in 2022 on the back of a very strong 2021. The core risk lies around managing operating costs and margins. The current environment is a true test of the brand’s pricing power. However, it was encouraging to see Mavi’s digital investments across marketing, pricing, and supply chain management systems. They have built an in-house system that tracks the prices of all competitors and guides their own pricing decisions. We remain confident of Mavi’s ability to weather the storm. With a strong brand, a competitive edge and strategic acquisitions, we believe, the company will continue to drive shareholder value.
LOGO – Logo is an ERP solutions provider for mid- and small-sized enterprises across Turkey. It is a key beneficiary of the growing digitalisation and formalisation of the economy. We met with the CFO and IR in one of their sales offices with beautiful views of Istanbul. It was a Friday and we truly experienced the new flexi-working style of technology companies with a significant number of employees working remotely.
Logo is a leader in digital transformation offerings with solutions like e-ledgers, e-dispatch, e-invoice, largely web-based and transitioning to cloud offerings. It has over 120k customers across Turkey and Romania. Its products and services compete with those of SAP by offering similar features at ~50% lower prices. Recently, the Turkish government has been focusing on formalising the economy and is mandating smaller businesses to generate e-invoices. Logo continues to benefit from this and has built a strong recurring revenue base across thousands of customers. Logo continues to innovate (spending ~20% of revenues on R&D) and to release new products and to win new customers.
Logo employs over 1,300 employees and has won the ‘Best Place to Work’ accolade numerous times over the years. It is a pay leader in Turkey and has been able to attract quality talent. Macro and currency depreciation are resulting in some loss of talent to Europe, which does worry Logo’s senior management. We also see the ability to attract and retain talent as one of the key risks for Logo, but given the strong employee culture and incentives, we are confident of them navigating this well.
