Turk Telekom 'BB-/B' Rating Affirmed On Improving Credit Ratios; Outlook Remains Stable

  • We now expect a stronger Turkish lira against the U.S. dollar at 5.50 in 2019, compared with 6.90 in our previous base case.
  • Given that 72% of Turk Telekom's debt is denominated in U.S. dollars, the stronger lira, alongside cost-reduction initiatives, results in improved ratios for 2019-2020, notably S&P Global Ratings-adjusted debt to EBITDA of around 2.0x and free operating cash flow to debt above 10%, compared with 2.0x-2.5x and 10%-15%, respectively, in our previous forecast.
  • Although Turk Telekom's stronger credit metrics have prompted us to reassess the stand-alone credit profile to 'bbb-' from 'bb+', the ratings on Turk Telekom are capped by our transfer and convertibility (T&C) assessment on Turkey.
  • We are therefore affirming our 'BB-/B' ratings on Turk Telekom and are assigning our 'BB-' issue rating to the company's proposed U.S. dollar-denominated benchmark-size senior unsecured notes.
  • The stable outlook reflects our stable outlook on Turkey and our expectation that Turk Telekom will maintain solid operational performance.
DUBAI (S&P Global Ratings) Feb. 14, 2019—S&P Global Ratings said today that it 
took the rating actions listed above. 

The affirmation reflects the improved Turkish lira (TRY) against the U.S. 
dollar, coupled with Turk Telekom's focus on cost efficiency. These efforts 
translate to better free cash flow generation and debt to EBITDA. We also 
incorporate into our analysis our ratings on Turkey (unsolicited, foreign 
currency B+/Stable/B, local currency BB-/Stable/B).

The lira has stabilized since August 2018, ending the year at TRY5.3 for $1, 
stronger than our previous forecast of TRY6.90:$1. This led us to revise our 
foreign exchange assumptions by about 15%-25% for 2019-2020, and we anticipate 
it will positively affect projections of Turk Telekom's debt and capital 
expenditures (capex), since the majority of the company's debt and about 50% 
of its capex are denominated in U.S. dollars and euros. 

Although inflationary pressure persists (S&P Global Ratings' assumption for 
consumer price index (CPI) growth to peak at about 20% in 2019, before 
tapering off to less than 10% in 2021), we expect Turk Telekom will likely 
maintain relatively stable margins of around 37% (as adjusted by S&P Global 
Ratings) throughout our forecast period. This is mainly since we expect the 
company's focus on cost efficiency, especially on the commercial costs, to 
offset the inflationary pressures. We continue to expect Turk Telekom will 
have stronger free operating cash flow (FOCF) generation than its peer 
Turkcell, mainly thanks to the former's leading position in the higher-margin 
fixed segment position. 

As a result, we now expect adjusted FOCF to debt will exceed 10% and adjusted 
debt to EBITDA will fall to about 2x from 2019. This compares with FOCF to 
debt between 10% and 15% and debt to EBITDA between 2.0x-2.5x for 2019 in our 
previous forecast (debt to EBIDTA stood of 2.4x in 2018).

Our views of Turk Telekom's business risk profile and our ratings above the 
sovereign assessment are unchanged. In addition, the recent ownership change 
has no impact on our view at this time, since we consider that Turk Telekom's 
articles of association constrain the special purpose vehicle's influence on 
Turk Telekom's dividend policy. We still expect a subsequent change in 
ownership of Turk Telekom at some point but have no details about timing or 
potential implications of a longer-term shareholder, which we would assess 
once it takes place. For more details, see our full analysis "Turk Telekom," 
published Dec. 12, 2018, on RatingsDirect.

The stable outlook reflects our stable outlook on Turkey and our expectation 
that Turk Telekom will maintain solid operational performance. Our current 
assessment of Turk Telekom's stand-alone credit profile incorporates our 
expectation that, in 2019, the company's adjusted debt-to-EBITDA ratio will 
remain below 2.25x and FOCF to debt will exceed 10%. 

A negative rating action on the sovereign could trigger the same action on 
Turk Telekom. We could also downgrade Turk Telekom if we revised down our T&C 
assessment on Turkey, due to deterioration in Turkish corporations' access to 
domestic and external liquidity, or if we believed the business risk of 
operating in Turkey had materially increased.

We could upgrade Turk Telekom if we took the same action on Turkey and revised 
up the T&C assessment.

Turk Telekom is a former incumbent telecom operator and provides integrated 
telecommunication and technology services to residential and commercial 
customers, primarily in Turkey. It predominantly offers fixed-line telephony, 
broadband Internet, TV, corporate data, and mobile telephony services, as well 
as infrastructure and wholesale voice and data services. As of Dec. 31, 2018, 
Turk Telekom reported 9.9 million fixed-voice lines, 10.9 million broadband 
internet subscribers, and 21.5 million mobile subscribers.

In December 2018, Turk Telekom announced the completion of the transfer of the 
shares from Ojer Telekom├╝nikasyon A.S's ("OTAS"), which owned 55% of the 
shares, to Levent Yapilandirma Yonetimi A.S. (LYY). LYY is a special purpose 
vehicle owned by the group of lenders of OTAS, including Akbank (35.6%; not 
rated), Turkiye Garanti Bankasi (22.1%; B+/Stable/--), and Turkiye Is Bankasi 
(11.6%; B+/Negative/B). The Turkish government (including the Turkish Wealth 
Fund) holds a 31.7% stake in Turk Telekom.
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