A Brief Look at the 3Q18 Financials from the Net Debt Perspective
Back when I started working, publicly listed Turkish companies tended to be prudent about risk management when it came to debt. A leverage of 1.5x operational profit (or EBITDA) would have been considered marginally high and a lot of companies were in net cash position. Looking back, I wonder whether this was by choice or by design i.e. lack of credit availability.
Fast forward to the 3rd quarter 2018 and the picture is very different. First of all, non listed companies have tons of debt and given their governance standards would not be superior to the listed ones, sustainability of the leverage is a big question mark which is already playing out with ongoing economic problems. Secondly, when we look at the listed companies, the universal trend is that their net cash positions have been deteriorating for a while which was only exacerbated by the faster depreciation of TL.
It is easier to blame TL weakness for the increase in debt but for many years these listed companies paid dividends instead of paying down debt, borrowed short term to fund working capital needs that kept growing and borrowed medium term for investments with unclear cash returns. While the recent TL weakness has effected through the short FX position channel, these trends were already well in place.
Coming to the TL weakness, annual inflation from November 2017 to October 2018 is around 25% CPI and 45% PPI. USDTL hit 4.00 in November 2017 and a year later is at 5.35, thus its 34% devaluation is the average of CPI and PPI. Therefore, other than slowing down the economy significantly, the past year’s events have neither provided a sufficiently weak currency nor are the main cause of the increase in net debt position of the listed companies. That problem lies in the mindset of the economic actors which seem not to have changed even now.
The figures below are from 10 leading non-financial Turkish companies which I’ve chosen from the investment reports by Garanti Securities. I’ve used the figures from the reports to indicate the overall picture which stands as follows:
What the table summarizes in the first section is the Net Cash position of the companies in TL terms as of the end of the 3rd quarter in 2017 and at the end of the 3rd quarter in 2018. Then in the second section 9 month cumulative EBITDA for 2017 and 2018 is listed. In the final section, Net Debt divided by 9 months of EBITDA ratio is calculated as a coverage metric. Negative figures in the Net Cash section indicate a position of net debt.
In the Net Cash section, we observe that these companies net cash position has dropped by 77% in a year. This translates to 44.6 billion TL increase in debt position. Of the sample, only Eregli Demir Celik had a positive cash position in both periods.
In the EBITDA section, we observe that these companies EBITDA has increased by 55%. This translates to 15.2 billion TL increase in EBITDA. Of the sample, only Vestel increased its EBITDA more than its net cash position changed.
Finally in the coverage section we observe that Net Debt as a multiple of 9 month cumulative EBITDA has increased from 2.10x to 2.39x.
What can we read from these results:
· EBITDA increase is above both PPI inflation by nearly 10 percentage points. (and further above CPI and TL depreciation).
· Whether this EBITDA boost is an inventory effect and/or cost cutting effect and/or scale effect would be clearer in a year. My expectation is that a significant portion of this could be a one-time margin gain which would erode in the latter quarters.
· Except for Eregli Demir Celik, this sample has significant debt regardless of the different industries they are in.
· Total debt has increased more than EBITDA by 22 percentage points. Thus favorable income level dynamics have not been reflected to the balance sheet.
· A part of balance sheet weakness is the dividend effect and another part is funding the working capital in a slowing cycle. I would expect some positive improvements on these fronts in the latter quarters but not enough to change the overall picture.
In summary, it would be interesting to have a 15 year analysis on these metrics to observe what changes took place. For now, with this sample and beyond, the Turkish companies have benefitted from the first wave of inflation at the greater expense of their balance sheet. If the income level changes do hold then there will be an opportunity to pay down some of the leverage which would also help to delever the overly leveraged Turkish economy. However, if the income level changes subside and/or debt is not paid down, there will be further rounds of corporate anxiety in not too distant future.
November 2018