Once again, we send our condolences to the relatives of those who lost their lives and to the whole nation. We wish healing to the injured ones. As Galata Chronicles, we thought it would be appropriate to wait for some time to talk about issues other than the earthquake and its tragic consequences because people’s priorities in our country were far from normal times. Our hearts go out to everyone affected by the earthquake. It will be very difficult for us to return to normal life and our daily agendas.

Instead of a thematic post today, we will take a brief look at some data that has been published since our last markets post. These are sectoral export data, consumption goods imports, PMI data, and credit/debit card expenditures. A few points will follow.

Sectoral Export Data

The Turkish Exporters Assembly (TİM) has published the export data for January and February.

In January, we see that the leather and leather products, automotive, electric electronics, and cereals-legumes sectors increased their exports strongly on an annual basis. On the other hand, the steel, defense and aerospace, and fruit and vegetable products sectors showed a negative performance in terms of exports in that month. In February, with the negative impact of the earthquake, the exports of many sectors slowed down on an annual basis. The Ministry of Commerce announced that the earthquake affected the headline export in February by 1.5 billion dollars negatively (this is the direct impact). Total exports in the month amounted to 18.6 billion dollars. In both January and February, electric electronics performed quite well on an annual basis. On the other hand, the poor performance of the steel sector continued this year.

Consumption Goods Import

Because of the fact that the Lira appreciated in real terms recently (both inflation and income-adjusted), consumption goods import volume rose significantly in 2022. We think that this situation will continue if the flattened course in the USDTRY continues. People buy imported goods they need when the Lira is relatively strong compared to the last few years. This situation seems likely to continue at least until the elections. Companies that sell imported products (distributors like TKNSA or DOAS) can take advantage of this situation in terms of sales growth.

PMI Data

The headline PMI realized as 50.1 in February, unchanged from the previous month. However, the primary reason behind the above-threshold headline data is the rising delivery times of the suppliers, hugely affected by the earthquake. The delivery times of the suppliers are inverted in that calculation.

The effects of the earthquake can be observed in almost every data because of its widespread destruction. Ten provinces have been affected by the earthquake. According to JP Morgan Research, they correspond to 9.3% of Turkey’s GDP, 8.5% of exports, 5.0% of tax revenues, and 11.1% of active employees. The three worst-affected provinces (Hatay, Adiyaman, and Kahramanmaras) account for 2.6% of GDP, 2.2% of exports, and 2.3% of tax revenues.

The earthquake in Turkey affected a very large area. The maps below, published by Reuters, show the size of the ruptures relative to other well-known lands. It is massive!

According to sectoral manufacturing PMI data, four out of ten sectors were in the growth zone, while six remained in the contraction zone in February. The earthquake affected all sectors of the Turkish manufacturing industry to a certain extent. The destruction and chaos caused by the earthquake affected the production level and supply chains. Delivery times significantly increased in some sectors. The production level decreased in nine out of ten sectors.

Among the sectors, chemicals, basic metals, vehicles, and machinery were the ones that performed positively. Textiles, clothing, and food products showed the most negative performances.

Credit/Debit Card Expenditures

According to the credit/debit card expenditure data announced by the CBRT, the categories with the highest annual growth in the last 4-week period were insurance, contractor services, car rental, and associations & social services. Aids made to non-governmental organizations due to the earthquake was the primary reason behind the growth in the social services and associations category.

In the same period, airlines became the worst-performing category. Evidently, airline companies use their capacity for international flights more and more due to the decrease in domestic purchasing power and price ceilings. International passenger traffic will be a more important indicator for the companies' financials.

Exceptionally Good

We have often pointed out that macro conditions are challenging for some exporters due to the appreciation of PPI-based real effective exchange rate and the slowdown in economic activity in most export markets. However, we also believe that companies that produce value-added products can still perform well, especially in terms of sales growth. One such company is YUNSA, which produces woolen woven fabric, a high-value-added branch of the fabric industry. YUNSA accounts for 70% of Turkey’s woolen woven fabric exports and meets about 5% of the world’s woolen fabric market, making it a strong player in this niche segment. Woolen woven fabric export data, which is a leading indicator for YUNSA’s sales, showed positive YoY growth in dollar terms in November and December last year, and this trend continued in January this year.

The Headwind for Mavi Giyim (MAVI)

We did detailed research on Mavi Giyim (MAVI) before. While we think Mavi still has strong financials, we would like to point out a headwind. Approximately 80 percent of Mavi's costs are in TRY terms, and it has TRY-based product pricing. Mavi's multinational competitors generally use FX-based pricing. In times when the exchange rate rises sharply, Mavi’s TRY-based product pricing allows it to offer competitive prices and gain market share. However, the exchange rate has been following a flat course for a while, and costs in TRY terms have increased significantly. This is a clear headwind for Mavi's price competitiveness and market share gains. Please take it into consideration.

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

As you may already know, Turkey was struck by two devastating earthquakes with magnitudes of 7.8 and 7.5 and hundreds of aftershocks, causing over 35,000 deaths and widespread damage to homes, businesses, and infrastructure.

The impact of this tragedy has been felt by everyone in the country, including our team at Galata Chronicles. We have been deeply affected by the scale of loss and the immense suffering that so many have had to endure. In light of this, we believe it is important to take a moment to acknowledge the human toll of this disaster.

As we all process the magnitude of what has happened, we want to urge our readers to consider donating to charities that are actively involved in providing relief to the affected communities. Your support can make a significant difference in the lives of those who have lost everything.

Organizations like the Turkish Red Crescent, AFAD and many others are working tirelessly to provide essential supplies and support to those in need. One of our own was in the epicenter of the earthquake until yesterday, helping the efforts. With donations, they can continue to provide critical aid to the people affected by the earthquake. Every little bit counts, so even small contributions can make a meaningful impact. If you want to help through official channels, here are the websites for doing so:

https://www.kizilay.org.tr/Bagis/BagisYap/405/donations-for-earthquake-in-pazarcik

https://en.afad.gov.tr/earthquake-donation-accounts

If not, as we said, there are a lot of trusted charities, so just pick one you like.

We are committed to continuing to provide you with insightful articles on the Turkish economy and finance and we will continue doing what we do quite soon, but we feel it is important to take a moment to acknowledge the crisis that is unfolding in our country. Our hearts go out to everyone affected by this tragedy.

Thank you for your understanding during this difficult time.

Sincerely,

The Galata Chronicles Team

Doğuş Otomotiv (DOAS) is an automotive importer and one of the largest distributors, operating in Turkey. The company has wide networks in the country that enables a strong market position. The company offers a diverse product portfolio consisting of Audi, Bentley, Cupra, Lamborghini, Porsche, Seat, Škoda, Scania, and Volkswagen (both VW passenger cars, and commercial vehicles). In addition, the company offers some services like vehicle inspection, marine services, second-hand vehicle sales, insurance, auto lending, etc. As a pure importer, the company differs from other publicly traded companies in Borsa Istanbul. The significant difference is that the company is fully exposed to the risk of Turkey, which brings advantages and disadvantages from time to time.

Let’s look at the domestic market briefly. In 2022, we saw that the demand for automotive (specifically, passenger cars [PC], and light commercial vehicles [LCV]) is relatively strong in terms of units sold in the Turkish market, indicating a 6 percent YoY growth, although it is below the ten-year average, according to the Automotive Distributors and Mobility Association (ADMA). If vehicle availability had been high last year, it could probably have exceeded the ten-year average.

We think that buying a car has become an important investment tool (rather than consumption) for people in an environment of high inflation and low-interest rates. This dynamic supported the demand in the market. Evidently, people bought cars with low interest-rate auto loans, compared to the inflation rate. This was also reflected in the vehicle financing growth, according to the data published by Banking Regulation and Supervision Agency (BRSA). The 13-week annualized momentum picked up quickly (the data also includes second-hand auto loans) (as of the week of 20th January). On the other hand, due to the skyrocketing prices in the housing market, automobiles have also started to attract attention as a more attainable investment tool.

As another indicator, the share of vehicle loans in total consumer loans increased meaningfully. In this case, another factor as important as consumer demand was the wider spread in vehicle loans, compared to other loan types, which incentivize the lender banks. Due to the measures taken by the CBRT, the spread seems to have disappeared in commercial loans for the banks right now. However, vehicle loans became the type of loan with the highest spread (7 points) after personal loans. These spreads are calculated by subtracting the weighted average deposit interest rate from the relevant loan rate (both are flow data).

In addition to the high demand environment for automobiles, fueled by the reasons we mentioned above, the chip crisis and the rapid depreciation of the Turkish Lira caused sharp increases in automotive prices in the last years. The supply-demand imbalance has reduced vehicle availability in the market, pushing the prices up. Due to the problems about vehicle availability, there is probably a significant pent-up demand left-over from 2022. The fact that vehicle sales have remained below the long-term average for the last 5 years also raises expectations for the coming years. There are reports stating that “more chips will become available in the second half of 2022 and the shortage is nearing the end”. However, “capacity still needs to be qualified for use in the automotive industry. Can the right matching occur between available supply and correct qualification? This is the difficulty that remains.”. So it is possible that these chips may not be the right type to satisfy automotive makers’ demands. As we understand it, even in the optimistic scenario, we should not expect the chip crisis to be fully solved before the end of 2023. Some reports talk about a period of a few years. The course of developments keeps its uncertainty.

Now let's get to know DOAS better and see how things are going for the company. In 2022, DOAS’s sales in terms of units decreased from 120,846 to 103,900, indicating a 14 percent decrease, according to Automotive Distributors and Mobility Association (ADMA).

One of the most important features for DOAS in recent years has been the decrease in vehicle availability. Despite the decrease in sales in terms of quantity, the company achieved quite high revenues, profits, and historically high-profit margins with the advantage of being the sole authorized distributor for important brands. In the chart below, you can see the company's gross profit margin and EBITDA margin, which were at their historical peaks. No doubt, this is a seller's market. Almost, the company sells its products as soon as they come off the production line. The company has sold products at pretty good margins without the usual discounts. Similarly, it probably had to spend much less on advertising and related expenses than before (cost advantage). Additionally, according to the information we received from the sector, being able to choose who will be the buyer (seller's market) was also a very important factor on the margins (option to prefer high-margin consumer types). We can expect the continuation of high margins until the chip crisis is over. It is obvious that the chip crisis has given the company tremendous pricing power. Strong demand, and tight supply. And guess what? Pricing power. We expect this situation to continue at least in the first half of the year. The easing in the chip crisis will be more visible in the second half.

(To note that carefully, if the chip crisis decreases the number of units sold, of course, the process could turn into a bad direction for the company. Right now, it’s about pricing than volumes.)

We would like to draw attention to other features enabling the company to capitalize on all of these dynamics. First and foremost, it is a great advantage that the company is the sole authorized distributor for critical, well-known, high-quality-perception brands. In addition, its products appeal to many different consumer groups, from affordable ones to very luxury models. These models are also in high demand in the second-hand market and can be sold at high prices (especially VW models). This situation gained even more importance due to the high inflation. Evidently, according to the research about the online passenger cars (PC) and light commercial vehicles (LVC) second-hand sales market in Turkey, conducted by INDICATA, in 2022, VW became the market leader in the second-hand online sales market with 247,113 units (14% market share). (In addition, in the second-hand online sales market, the average sales price increase since the beginning of 2022 has been 43 percent.). Looking at the sales speed of the brands, the data confirms VW's market power. In December 2022, vehicles were sold in an average of 28 days in the second-hand online sales market, while VW models were sold in an average of 23 days, making it the fastest-selling brand. In addition to the sectoral dynamics, with such structural advantages explained above, the company had high revenues, profits, and profit margins in the recent period.

On the other hand, as we said above, the company also has different business lines such as a vehicle inspection unit. The company has a stake in TUVTURK, the vehicle inspection unit. TUVTURK is a monopoly in this field in the domestic market since 2007. The relevant contract expired at the end of 2027. According to the information we received from the company's annual activity report, periodic vehicle inspections of approximately 11 million 275 thousand vehicles were carried out in 2021, an increase of 9.9% compared to the previous year. This business line is quite important for the company because inspection fees increased around 123 percent as of the new year. It will contribute to the company’s financials quite positively in 2023.

What to Expect?

For the company’s future financials, we think that three important factors are prominent:

i)                 Chip Crisis:

If the chip crisis eases, and the availability increases, it will support revenues but be detrimental to the margins because more competition will increase the price competition. We are at the historical peak of the margins. Therefore, this situation has serious risks for all DOAS investors, and we can say that is the main reason for writing this post. If availability increases, DOAS cannot minimize low-cost buyers (no more seller’s market). Be careful and take the margin normalization into the consideration!

ii)               Elections in Turkey:

After the election, what will be the exchange rates, and interest rates, and the outlook of consumer confidence will be very much important. High volatility in exchange rates makes pricing very difficult. In addition, sharp increases in exchange rates may affect sales negatively by causing a loss of purchasing power. If consumer confidence deteriorates, consumers may delay their demand until predictability is achieved. Interest rates will also be important in terms of both demand, and consumer sentiment. However, the share of the purchases made with the use of loans in the total sales of DOAS will be important.

iii)              Transition to Electrical Vehicles:

In Turkey, the share of electric vehicles in the total is low right now, indicating a strong potential. The number of electric vehicles is increasing rapidly. There are also significant opportunities for DOAS in this transition. Popular electric vehicle models of brands such as Audi, VW, and Porsche can be an important source of income for the company. It is highly probable that new incentives will be issued to increase the use of electric vehicles. The attempt of DOAS to install electric charging stations for Porsche’s Taycan models (a well-known electric vehicle in Turkey’s premium segment) is important in that respect.

However, at this point, it will be very important how much share Turkey's domestic brand TOGG will have in the premium electric vehicle market. It is undeniable that TOGG will be incentivized specifically by the decision-makers.

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

When it comes to inflation, granularity is key. You can't just look at the overall cost of living and call it a day. You have got to dig deep and pinpoint the specific drivers of price increases. Sure, food prices might be on the rise, but that's not the whole story. Maybe housing costs are skyrocketing because of a lack of supply. And that's where policy comes in - by identifying the root causes of inflation, policymakers can craft targeted responses that actually address the problem.

But it's not just about getting granular - you also need to take a sectoral perspective. Different parts of the economy can be feeling the heat in different ways. Raw materials prices might be driving inflation in manufacturing, while shifts in consumer preferences might be pushing up service sector costs. There are usually no standardized inputs that can be substituted easily and smoothly and sector-specific cogs-of-the-machine matter. One-size-fits-all policies won't cut it - policymakers need to tailor their responses to the unique inflationary pressures facing different sectors.

And let's not forget about interlinkages - the economy is a complex, interconnected system. A surge in energy prices might lead to higher costs for manufacturers, which in turn leads to higher prices for consumers. To truly understand inflation and address it effectively, policymakers must account for these ripple effects and anticipate the potential knock-on effects of policy decisions.

As we said in the beginning, we don’t think anyone would object to these statements, but if we dig deeper, it turns out a lot of people agree in principle but disagree in practice. And we understand why.

Somewhere along the way, we decided that monetary policy needs to be taken away from the hands of prying politicians who might instrumentalize it to win elections and not care about inflation and when faced with high inflation, they wouldn’t choose to follow policies that were needed to bring it down, fearing high unemployment. Don’t mind the illusion created by the word “we” there. “We” actually didn’t do it, some unelected technocrats did and these folks then persuaded politicians to enact laws and regulations that made this happen. Said politicians were apparently happy about this because they now had people to point to and blame if inflation was high so the interest rates had to be high (which, it turns out, is a hilariously misguided view and politicians still take the hit in their approval ratings during high inflation episodes, despite central bank independence, so central bankers pulled a fast one on politicians here) and reap the benefits of a buoyant economy when inflation and rates were low.

In a lot of countries, people had enough of the problems and equity issues created by governments micromanaging the economy, treating different sectors and firms differently and the inefficiencies that emerged as a result of soft budget constraints, so technocratic management that was removed from politics appealed to a lot of people. So, if you can leave aside the mind-boggling ontological contradiction in this picture, it was a win-win proposition.

[That contradiction: If a politician is able to pursue expansionary monetary policy and win elections, why should anyone object as it would implicitly mean the general public is OK with this? A somewhat sensible answer is that because people hyperbolically discount future consumption. Much less wonkishly put, folks want to consume things today and care less about the future, so that politicians are inclined to throw caution to the wind near election periods and create an “inflation bias”. So in the context of inflation, this might mean the allure of more consumption today can cause folks to disregard the possibility of a higher cost of living in the future, which is a “bad” thing, so monetary policy decisions should be made independently, the reasoning goes.

The problem is, people acting this way is not only an issue for monetary policy but literally everything. So why stop at the monetary policy? Another plausible answer is that the first and foremost responsibility of a decision-maker is to avoid ruin and irreversible catastrophes, bad monetary policy decisions can lead to hyperinflation, which is particularly sticky and ruinous so that’s why central bank independence makes sense in a democratic context. But if so, a lot of other things might lead to ruin, like excessive government spending, which can lead to debt defaults, or war, which can lead to… I guess you know what it can lead to. So let’s remove all crucial decisions from the hands of elected people while we’re at it.

Anyway, this article is not meant as a rant against central bank independence. Paraphrasing Kyla Scanlon, economics is based on vibes, and central bank independence apparently is a source of good vibes, but let’s not pretend that it should not be controversial. Let’s continue.]

So central banks, initially tasked with preventing money market crises and balance of payments management, were then given the responsibility of managing inflation, and in the 90s, gained independence. The problem was, people started to act as if it was only the central bank’s responsibility to ensure price stability while not endowing it with any other tools than it had before, and frankly, central bankers weren’t too unhappy about this either. In the next 30 or so years that followed, developed country central banks and the periphery ones that were forced by the IMF eventually, by and large, controlled monetary policy with a single lever: the policy interest rate. And things pretty much turned out just fine, apart from a couple of global and regional financial crises, and massive off-shoring of manufacturing capacity here and there. And while such crises forced central banks to innovate and find some new levers, like the Fed and its QE programs, which in part targeted the housing market specifically by buying MBS, the paradigm never fully changed and inflation (or deflation) continued to be treated as an aggregate phenomenon. Because the toolkit central banks had didn’t allow a differential and nuanced policy anyway.

One big sign of this treatment is that the entirety of the language around inflation targeting and monetary policy is based on aggregate concepts: Like the r-star, the supposed interest rate level that is neither expansionary nor contractionary, NAIRU, the supposed lowest unemployment rate that can be achieved without being inflationary, or the CPI itself. We find it pretty hard to believe that the basket of prices and the corresponding weights assigned to the elements of the said basket a central bank needs to track and target to ensure overall dynamic price stability is the exact same basket that includes goods and services that people consume today statically and the weights are in accordance with how much people spend on each item “today”.

Now here is a massive caveat: We find this paradigm non-sensical “right now”. HOWEVER, it does not mean it was not somewhat appropriate to think in aggregate terms back then. And by “back then”, we mean the entirety of human history. Because if one operates in a low information environment, which was probably ALWAYS the case in the context of macroeconomics, pretty much up until now, it is not entirely a bad idea to avoid a sectoral and granular view as the likelihood of unintended consequences was rather high, so it was quite probable that, say, a price control or other selective monetary measure applied in a specific sector to control inflation there could blow up other sectors and destabilize things overall.

Though this caveat in no way justifies believing in insane, preposterous things like inflation being always and everywhere a monetary phenomenon, we understand why people wanted to act and think as if monetary policy was a sanitary, scientific affair divorced from politics, conducted by technocrats and operated via a blunt instrument that is the policy interest rate that applied to everyone in the same way with no differentiation whatsoever, as we said in the beginning. (China is possibly the biggest standout here with its 387 policy rates, 878 local implementations, price controls, etc.)

Why do we find this paradigm non-sensical right now? Because a recent paper by and an Odd Lots appearance of one of our favorite active economists nowadays, Isabella Weber, reminded us that a different and better way of thinking about monetary policy is in the cards in the very near future. In the paper, Weber analyzes inflation in a way that is very old, that is in existence for roughly a hundred years in some shape or form: With Input-Output Tables, so that possible spillovers can be quantified if a specific sector in the economy receives an inflationary shock, and how the overall inflation will be affected can be analyzed. This way she is able to show which sectors have a more sizable impact on inflation than their weights in the CPI basket would indicate.

And Weber has a couple of excellent suggestions for improving inflation targeting and shock-proofing the entire system. A remarkable one is the minimum inventory requirements for firms operating in sectors with systemically important prices that are selected as a result of this analysis. We are all somewhat familiar with the discourse about systemically important financial institutions and the necessity of regulating them so that they don’t blow up the entire system if anything happens to them. But it was definitely not accepted wisdom until such a blow-up actually occurred. Until then, those financial institutions were adamant that they were operating just fine without tough regulations. Well, it turned out that they weren’t. Now we will have to go through the same motions for the non-financial sectors. The most successful ones were applauded for having extremely lean structures and just-in-time inventory management systems. But it was abundantly clear that just-in-time inventory management systems created huge fragilities in the entire global economy. All successful regulations thread a needle between the burden of regulation and some advantages provided to the regulated by the regulators. In the banking sector, this is done by regulating the banks but giving them and only them access to the lender of the last resort facilities by the central bank. In the non-financial sectors, a similar thing can be done by the central bank creating a limited lending facility to help the regulated sectors accumulate and maintain the required minimum inventory.

Weber’s study largely discusses the situation in the US economy, and the US is a monetary sovereign. However, the vast majority of the global economy is quite dissimilar to the US, and balance of payments issues and exchange rate movements explain a significant chunk of the inflationary pressures happening elsewhere. So, if we apply the same granular analyses in the RoW, we think it should be possible to unearth which sectors and firms to provide incentives to, and which products to localize to ensure price stability. Some of this is already done in various forms as part of industrial policies of successful developing countries, but we think the instrumentality of this in an inflation-targeting context is under-appreciated and there is more central banks can do in this regard without violating their singular mandate of ensuring price stability.

As we said, there is little entirely new here, but this way of thinking has been unfortunately pretty much forgotten in the monetary policymaking space, despite academic studies continuing in the meantime, for the reasons we talked about here. However, central banks’ ability to track payments, firms, and prices is immeasurably better than it was 20 years ago, let alone 100. And it will get much better in the future with the introduction of central bank digital currencies, which might endow money with memory. This, along with the global trend towards lower and lower cash use might mean central banks would be able to track prices and sectoral moves in real-time so that analyses like Weber’s can be done more precisely, and central banks can act more swiftly if they face adverse developments that could create larger turmoil down the road.

It would still be a good idea to be humble about what conclusions to draw from this set of analyses, as we still don’t have a good grasp of the actual pricing processes and heuristics firms employ and it seems likely that we will never fully do, but we think it would be a definite Pareto improvement to stop talking about things like r-star and NAIRU because they not only do not exist for the whole economy but for sectors. Heck, it’s not even remotely clear that they exist for individual firms at two different points in time. So for this, because she and her co-authors reminded us this alternative way of thinking about things, we think we owe Isabella Weber a debt of gratitude.

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The Effect of the Strong Minimum Wage Hike

This week, we will look at the impact of the strong minimum wage hike on the sectors in Turkey. First of all, as you know, the net minimum wage has been increased to 8.507 TRY. This level means a 55 percent increase compared to the last July and a 100 percent increase compared to the last January. We tried to measure the impact of that increase on the companies’ margins. Our aim is to understand in which companies and sectors there will be pressure on the margins and which ones are more likely to face margin compression. It could be a way to look at the financial statements of the companies and analyze the personnel expenses. However, this would take a lot of time and not all companies share information in the same format, making the comparison difficult. In conclusion, to analyze the sectoral impact, we looked at the annual industry and service statistics published by Turkstat. After the sectoral outlook, those who wish can make further research about the specific companies. However, we think it is important to see the sectoral outlook. In the annual industry and service statistics, Turkstat publishes the number of enterprises, number of employees, personnel costs, turnover, production value, and value added at factor costs in each sector based on NACE Rev.2 codes. By dividing personnel costs to value added at factor costs (the main determinant of profit), we tried to understand how much of an impact rising personnel costs can have on margins. We think that this is the ratio that helps us to understand the impact. Let us share the table with you first, and then I would like to draw attention to a few points.

Source: Turkstat, Galata Chronicles’ Calculations

Source: European Commission

Expressions in parentheses here indicate NACE Rev.2 codes. Some of the sectors in the table are the main groups and some are sub-sectors. We selected certain sectors and sub-sectors using NACE codes. For your better understanding and convenience, we also share the table showing the codes of the main groups above. So, you can better understand and locate the categories.

We should emphasize the importance of identifying which company falls into which category. For example, apparel (C14) is a sub-field of the manufacturing industry, as it can be understood from its NACE code because it has the letter C at the beginning. Therefore, a non-manufacturing company that only retails apparel falls into the retail (G47) category, not the apparel (C14) category. The second table above will guide you in that respect.

Now, if we come to the results, we see that sectors such as leather manufacturers, retailers, apparel manufacturers, hospital services, furniture manufacturers, and construction are the sectors that are likely to feel pressures in their margins. However, this does not mean that companies will inevitably experience a decrease in their margins. It will be important which companies can overcome this pressure by using their pricing power. Therefore, demand conditions in these sectors, the other COGS and OpEx items, etc. will also be important. As we have emphasized in our previous articles, we think that retailers in general may be more resistant to this pressure due to the high demand of the end consumer. Because we think the other supporting factor for retailers is falling commodity prices (cotton for apparel retailers, for example). On the other hand, electricity, basic metals, and chemicals stand out as sectors that can be affected by a minimum wage hike less.

In the meantime, of course, the minimum wage hike will also have an impact on the demand side. For example, we can expect an increase in demand on the consumer discretionary side. We should note that we also expect this trend to differentiate regionally (regional discrepancy). To be clear, consumer discretionary demand in Istanbul may be weaker compared to other provinces, as the increase in prices and rents is strong in Istanbul comparatively.

In general, we like retailers as the investment theme, at least for the first half of 2023. Because steps are constantly being taken to keep end-consumer activity high (populist steps on the eve of the election). Demand conditions are good so far, which can be seen in the debit and credit card expenditure data. High demand increases the pricing power. We learn that retailers are not fully utilizing their discount budgets. On the other hand, the tight monetary policy applied in global markets keeps raw material costs down, which is positive for retailers. Moreover, at least for now, there is no problem on the USDTRY side. It is also important to note that retailers will not be affected too much by the slowdown in export markets either because their exports are comparatively quite low. However, the discussion of which and how much cheap such companies are in terms of valuation is a separate question that needs to be answered meticulously.

A Different Perspective on the Re-opening of China

Let's move on to another topic we want to look at this week. Everyone is discussing when the China re-opening will happen. This will be very important for global markets because it is clear that what happens in China does not stay in China, as William L. Barcelona et. al. argued.

When we consider the re-opening issue in terms of tourism and airlines, it will have important effects. As HSBC stated recently, the Asia region has the largest potential upside in that respect.

Source: HSBC

It will certainly have implications for Turkey as well. We think that this situation may be positive for Turkish Airlines (THYAO). When we look at THYAO's traffic data, there is a very positive picture compared to 2019 levels in all other regions, while the traffic in Asia (Far East) is comparatively far from 2019 levels. The tables below show THYAO's traffic data by region in 2019 and 2022.

Source: Company data, cumulative

The re-opening of China will strengthen THYAO's hand in maintaining and growing its sales. However, it will be important whether THYAO will have sufficient capacity to meet the demand in this region. It is stated that THY will increase its capacity by 17-20 percent in 2023. Under these circumstances, we welcome this situation.

Exceptional Exporter

Recently, we have had very negative words for textile manufacturers. Factors such as the slowdown in export markets, the effect of minimum wage hikes, almost flat exchange rates, rising PPI-based real effective exchange rates, falling capacity utilization rates, and layoffs were discussed a lot. However, we put YUNSA (Yünsa Yünlü Sanayi) aside. The company produces woolen woven fabric. In other words, it works in a high-value-added branch of the fabric industry. We estimate that this is the tailwind for the company's sales. Woolen woven fabric export data, which is the leading indicator for the company's sales, grew quite strongly YoY in November and December.

Source: Istanbul Textile and Raw Materials Exporters' Association (İTHİB)

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The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

We’re back, with our very first Q&A and in our inaugural session we’re glad to have Mr. Haydar Acun with us. Our guest needs no introduction for those with even a modicum of knowledge of the Turkish fund management industry. He is a successful fund manager in Turkey, the founder of Marmara Capital asset management company and he manages two equity funds (namely, MAC mutual fund, and MAS hedge fund). Mr. Acun frequently and deservedly drew attention with the returns of his funds in recent years and his portfolio management style based on value investing.

We’re grateful that he accepted to sit down with us.

Have a nice read!

Galata Chronicles: Could you please tell us about yourself, and Marmara Capital briefly? When did you start working in this sector? When and how did you decide to establish Marmara Capital? What about your funds?

Haydar Acun: Around 30 years ago I started my career as a security analyst at one of the local brokers in Turkey then moved to London to work for Schroders Securities covering the Turkish market. Between 2006-2014 I founded and managed Sardis Securities, a value-driven boutique brokerage firm. Finally, I am managing Marmara Capital since 2015.

We launched our MAC fund in 2014 and our second fund MAS in 2021. As of now, MAC is the largest equity fund (without limitations of an index fund) in Turkey with the highest number of retail investors (around 45k). Not only that MAC is the best fund in terms of performance both over the past 3 years and 5 years, outperforming the market nearly by 5 times since its launch.

GC: Why did you decide to follow this path?

HA: Early in my career, I realized that I want to be on the buy-side rather than the sell-side, for a couple of reasons: I like picking up stocks, which I believe I am good at. Success and failure are easily observable and can be measured quickly and clearly, and how well you do is entirely up to your own decisions, and you are not at other people’s mercy.

GC: As a portfolio manager, what is your investment strategy for the Turkish equity market? Do you trade a lot in your fund, or do you have a long-term perspective, for example? What learning stages and experiences did you go through until you arrived at this strategy? Who are the investors you are most influenced by in the field of portfolio management?

HA: Our investment strategy is to buy and hold stocks trading at discount to their intrinsic values. This usually involves buying unpopular stocks during “unpopular” times, so we are, in a sense, contrarians.

Our portfolio turnover rate is well below one time. I have been a Ben Graham admirer for a long time and trying to do his cigar-butt investing but these days I’m trying to adapt more to the dictum “buy good businesses and do not be overly concerned about their valuations”. In my career, I have met many great investors personally, but no need to say Charlie Munger and Warren Buffet are at top of the list.

GC: Can you explain your value investing approach and why you believe it is an effective strategy? And will it outperform in the future, given the deeply negative real interest rates in Turkey, a factor that was identified by Howard Marks in his latest note as a key reason behind value underperforming in the US after the global financial crisis of 2008?

HA: Well, to be frank, we think value investing is the only way of investing. What is “investment” after all? Laying out money you saved today to earn a satisfactory return in the future. In the end, the value of anything depends on its cash generation capability and as Ben Graham puts it, a stock market is a weighing machine in the long-run, so, this fact about value asserts itself sooner or later. Stocks of companies generating good rates of return will eventually outperform the rest.  Despite deeply negative rates in Turkey that was in place for more than a year, our investment approach worked, and we outperformed using our strategy, and I believe temporary anomalies in the macro picture can only create temporary setbacks but in the long-term the result will not change.

GC: How do you identify undervalued companies in the Turkish equity market, and what factors do you consider the most when making investment decisions? Do you use any systematic approaches or is it purely discretionary?

HA: We filter around 100 investable companies regularly in terms of corporate governance, liquidity, etc. If we see a price anomaly, then we take a closer look. We pay a visit or sometimes we invest without meeting the company. Investing is making decisions with incomplete information. There is no formula, and we are flexible about how we value a company. After all, I think it is a simple question: If you had inherited a large wealth, would you buy this company as a whole or not?

GC: As a long-only investor, how do you manage risk in different market regimes?

HA: For us, what constitutes risk is not the Beta of stock [the relationship between the variation in a stock’s price and the variation in the overall market price – GC], or how volatile a stock is. The actual risk is if you’re wrong in your investment convictions and if you are overpaying for a stock. We go ahead and try to buy more if something got cheaper. Would you stop eating hamburger if the price is halved? Probably not, right? So, we do not use stop-losses and neither do we believe in the concept.

GC: You have been known to caution investors from reading too much into past returns. In your opinion, how long should it take to evaluate whether a stock or fund investment is successful or not? How should investors tell if success should be attributed to fund or company management skill vs. luck?

HA: I think a minimum of 3 to 5 years is needed to conclude if a fund is successful or not. I think the most important thing in evaluating a fund is to look at how that fund’s performance is created and not the performance itself per se. What kinds of risks does it take? The principles and methods pursued are more important than the results. Alignment of the interests of the investor and the fund manager is also crucial. After all, our business is full of conflicts of interest.

GC: As Howard Marks emphasizes frequently, there is an “oscillation in securities markets between euphoria and depression; between celebrating positive developments and obsessing over negatives; and thus, between overpriced and underpriced assets.”. Of course, this weakness in human nature creates great opportunities for intelligent investors. Would you like to share with us your experiences in this respect? How do you stay calm in times of panic?

HA: Humans, unfortunately, are not prone to change, so fear and greed are and have always been the main motives that drive the markets. Given this fact, being a contrarian requires staying calm and keeping an eye on the fundamentals, the “value”, of the businesses rather than mundane share price movements. Investing is largely a character business above all.

GC: What do you think about the differences between developed markets and emerging markets in terms of portfolio management? What are the main differences? In terms of portfolio turnover rate, for example? Can you discuss any challenges or obstacles you have faced while implementing a value investing strategy in the Turkish market specifically, how have you overcome these challenges? Are there any advantages?

HA: Emerging markets are, at their core, inefficient markets. That’s why it is easier to make money in EM. There are a lot of day traders that trade on what’s basically noise, and this creates volatility, and volatility means opportunity. In developed markets, let’s say in the UK, probably a peer group fund, compared to us, has a significantly less turnover rate but one should compare apples to apples. In a market like Turkey where there are more frequent and bigger swings in the market and where stocks overshoot or undershoot regularly, it is normal to have a higher portfolio turnover rate, for example.

GC: As an experienced portfolio manager, what advice would you give to investors looking to invest in the Turkish equity market for the first time? Do you think that are there any advantages to investing in funds rather than picking stocks for foreign investors as well as for residents?

HA: Not everybody has the capacity, in terms of financial literacy or psychological mindset, to be an investor, so for those newcomers, I would suggest they consider investing in funds rather than directly buying stocks. You should not own a stock unless you know why you own that stock, and you should have your own investment convictions.

GC: Can you discuss any recent trends or changes in the Turkish equity market that investors should be aware of? Which sectors or stocks do you think will stand out in 2023? What are your expectations regarding Turkish markets?

HA: We do not make macro forecasts and try to guess where the market will go. So, this is just wishful thinking on my part, but I hope to see a better market with more foreign participation in 2023. Turkish investors started to discover the fund investment world and I believe this trend will continue.

GC: You organized a meeting day with investors this year. How did it go? Do you plan to continue?

HA: It went well. It was the first of a kind, and we plan to do it every year in order to improve investment awareness among local investors.

GC: What are your future plans at Marmara Capital? You recently announced that you will raise the investment ceiling in your funds. Might your fund getting larger cause issues in micro and small-cap allocations?

HA: We will keep doing what we do. We do not want to be too big. We want to be the best and enjoy our life, create value for our investors and shareholders. We increased the number of funds shares available because of high investor demand. The Turkish market is big, and liquid and I believe we can manage more money but the moment we feel our performance is in jeopardy due to our size then we can limit the new investors.

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Let’s start with the latest situation and contextual tailwinds.

The furniture sector has an important place in the Turkish economy with its manufacturing capacity, employment level, exports, etc. The sector performs well this year despite all uncertainties and challenges. Furniture expenditures increased by 101% in the first 50 weeks of this year compared to the same period last year (according to the debit and credit card data, published by the CBRT). This growth is above the headline inflation (84.39%) and the sub-category of furniture inflation (%92.83). Right now, in Turkey, people consume in attainable areas in order to protect themselves against inflation. This situation creates traffic on the retail side, which is a clear tailwind for furniture retailers as well. We expect an increase in the shopping appetite in 2023 for durable consumer goods including furniture after the strong minimum wage hike, announced recently. Things seem to be going well in the domestic market despite the challenges.

For a while, the sector’s capacity utilization rate has been above the rate of the durable goods sector.

Source: CBRT

Let’s look at the exports side. While Turkey's total exports increased by 14% in dollar terms in the first 11 months of the year, furniture exports increased by 25%. It indicates that contrary to many other sectors that have problems due to the slowdown in economic activity abroad, Turkish furniture manufacturers maintain their relatively strong position in the export markets. It is exceptional. For example, having a similar cyclicality in terms of sensitivity to economic activity, the electrical and electronics sector has increased its exports by just 6.7% annually since the beginning of the year. Similar to the domestic market, there is a relatively positive scenario here.

On the costs side, as noted in the latest report of Garanti Securities (written by Emin Tay), the significant decrease in TDI prices (toluene diisocyanate, an important raw material for the sector) will also create a significant cost advantage in 2023 and is likely to help the margins. According to the industry and service statistics announced by Turkstat, the share of labor costs in the production value is 13.1% in the furniture sector. Considering a 55% increase in the minimum wage, we think its impact will be limited compared to the advantage coming from the decline in TDI prices.

If we look at contextual catalysts ahead of us, a possible mortgage package that government might announce towards the election, or the social housing project will certainly have a positive impact on the sales. Moreover, the house renewal projects (run by the Environment and Urban Ministry) or the possible increase in demand that may arise from the migrant/foreigner interest in Turkey (those who buy the house to obtain citizenship) have the effects. However, we cannot quantify their effects properly.

Currently, the housing supply in Turkey is not even remotely at a sufficient level. A normalization of costs in the construction industry seems likely in the coming years, and this might unleash an expansion in the housing supply, and this situation will be also positive for the sector.

To summarize, in addition to the possible catalysts ahead of us, the situation in the domestic and foreign markets is not bad despite various challenges.

In addition to these contextual dynamics, three structural/secular factors make us think that the future is bright for the sector.

1)      Demographic Factors

We think that some demographic factors will keep the furniture demand relatively stable (risks are quite limited for too steep a decline). It means that these factors are likely to shield the sector from cyclicality to some extent (we do not say here that it will be as if there is no cyclicality, of course, there is and will be). What are these structural factors?

According to the data published by Turkstat, the number of marriages in 2021 was around 560 thousand in Turkey. The crude marriage rate, which represents the number of marriages per thousand people, was 6.68 in the same year. On the other hand, the number of divorces in 2021 was around 174 thousand. The crude divorce rate, which represents the number of divorces per thousand people, was 2.07 in 2021. To summarize, based on a 10-year average, around 700 thousand new households are formed every year in Turkey due to marriages and divorces. While Turkey’s crude divorce rate is around OECD and EU averages, the crude marriage rate is well above them. On the marriage side, we do not expect this dynamic to suddenly disappear in Turkey because of the factors such as the relatively higher young population ratio and religious/cultural favor towards marriage. Marriage is something that is encouraged in Turkey. According to 2019 OECD data, the male mean age at first marriage in Turkey was 28, while OECD and EU averages were around 33.

Source: Turkstat

Source: OECD

Source: Turkstat

Source: OECD

Let's put the marriage and divorce data aside. The average household size in Turkey is declining. The average household size in Turkey, which was 4.0 people in 2008, showed a steady decline and fell to 3.23 people in 2021. The ratio of single-person households consisting of individuals living alone, which was 7.9% in 2011, increased to 18.9% in 2021. The high rate of new household formation supports the furniture demand.

Source: Turkstat

We think that the aforementioned factors create fresh demand every year and keep the downside risks more limited.

2)       Possible Consolidation

Compared to other sectors, the furniture sector is highly fragmented.

CBRT publishes the financial data of the sector by compiling the financial tables of individual real sector companies (by using individual data and aggregating them). In the 2021 dataset, there are nearly 1 million companies’ data.

In the dataset, the companies are divided into four main groups in terms of size (micro, small, medium, and large ones). Companies that employ more than 250 people and whose annual net sales revenue or financial balance sheet exceeds 25 million Turkish Lira fall into the “large” category. We compared the furniture sector with the manufacturing sector in general. According to the data, while the share of large companies in total net sales is 74,4% in the manufacturing sector, this share in net sales falls to 36,6% in the furniture sector (a total of 9101 furniture companies included, we think this is indicative). It is comparatively quite low. This share was 31% in 2018. Going to earlier years may not be very accurate by using this data due to some methodological differences.

Source: CBRT

Source: CBRT

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Unbranded products are common in Turkey. We think that large companies with economies of scale, operating leverage, and that can afford high advertising expenditures can gain market share from small and unbranded product manufacturers in the upcoming years. Even when the market is not growing, this can have a relatively positive impact on sales for large companies.

We accept that the furniture industry is more open to fragmentation due to its characteristics, but we think that there is room for gradual consolidation. Since 2011 in the US, the share of furniture store business done by the Top 100 stores has grown from 62% of sales to around 85% in 2021. We think that a similar consolidation will take place gradually in Turkey (although probably will remain below manufacturing sector averages).

Therefore, we see this dynamic as an opportunity for big players (YATAS, or DGNMO amongst the publicly-traded ones, for example). Strong marketing efforts can help large companies build a loyal customer base and increase their market share. Moreover, they can seek out acquisitions. They can capture the recent dynamics and product trends in the sector earlier and increase their market share easier, compared to the small players.

On the other hand, in terms of profitability, it is promising. When we look at the profitability of the sector by size, we see an increase in profitability as the size increases.

Source: CBRT

3)      Export Potential

Turkey can be an important opportunity for countries that want to diversify their furniture supply chain. It is known that some Western companies are interested in the furniture sector in Turkey. According to that source, ten furniture companies have opened a purchasing office in Istanbul.

In 2023, the sector’s export target is 10 billion dollars. The "distant countries strategy" supported by the Ministry of Commerce includes the goal of finding new markets for the furniture industry. In this direction, efforts will be made to expand operations in 18 countries such as the US, India, China, Canada, Mexico, South Africa, Australia, Nigeria, Brazil, etc. Currently, the share of neighboring countries such as Iraq and European countries such as Germany is higher in the sector's exports.

We think that with its location, manufacturing capacity, and abundant raw materials, Turkey has the potential to expand its operations abroad in that sector.

All in all, in addition to the current momentum and possible catalysts ahead of us, we think that there are medium and long-term tailwinds.

Lastly;

Now let's talk about two publicly traded companies in the furniture sector briefly (very brief overview in order to introduce them).

YATAS: The Kayseri-based company has an important position in the sector. The company operates in different segments with different brands (Yataş, Enza Home, Divanev, Puffy) and successfully targets different customer groups.

The company's revenue increased by 142% on an annual basis in the first 9 months of the year. Operating profit increased by 158% and net profit increased by 149%.

The company has steadily grown its sales area and number of stores in recent years, which is positive. The company is the second largest company in the country in terms of the number of stores. We also think that Yataş's brand perception is good in the eyes of consumers. We think that the company's ability to quickly identify consumer needs (such as the popularization of modular furniture) is an important factor in that success.

However, the company's margins have been under pressure recently. The process of reflecting costs on prices might be delayed. The decrease in TDI prices may have a positive effect in this respect.

In addition, we should point out that the company is far from the targets it has set for many years on the export side (currently around 10 percent). On the other hand, the share of online sales in revenues is still low (currently around 5 percent).

We think that the most important agenda items (in addition to macro and sectoral developments) for the company in the coming period are the course of raw material costs, the improvement of pricing ability and stabilization of margins, sales area and store growth, and export and online sales growth.

The company is currently trading at 10.8x P/E and 4.1x P/BV. The company's PEG ratio is at 0.09.

DGNMO: Doğan Furniture is a subsidiary of Doğanlar Holding. The company has five brands (Doğtaş, Kelebek, Lova, Ruumstore, Kelebek Kitchen&Bathroom). The company ranks third in the country in terms of the number of stores.

The company's revenue increased by 111% on an annual basis in the first 9 months of the year. Operating profit increased by 120% and net profit by 174%.

Especially after 2018, with the change in its senior management, the company has strongly increased the number of stores, significantly reduced its indebtedness, and increased its margins. In addition, the company has strong growth targets in segments such as beds, kitchen&bathroom furniture. According to the information we received from the sector, these products have a higher gross profit margin compared to other furniture products. On the other hand, the company has projects on the installation and optimization of logistics warehouses. This situation is likely to increase the optimization level and create a cost advantage. However, the margins follow a fluctuating course for a while. Margins are likely to stabilize as current investments mature.

The company is currently trading at 26.1x P/E and 9.0x P/BV. The company's PEG ratio is 0.50.

Thanks, everyone, and see you in the next post!

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

We also said this in our CPI analysis: 

“We think CBRT has the means to keep the Lira on an extremely mild depreciation path”

So in this 2-in-1 bonus macro piece, we will connect these dots, analyze the prevailing current account dynamics, talk about the rapid rise in the foreign exchange reserves of CBRT briefly, and list our expectations for Turkish Balance of Payments figures in 2023.

Let’s get started.

This week the Central Bank of the Republic of Turkey released the balance of payments statistics, and it was superb. The headline current account deficit figure came way below expectations and below even the most optimistic forecast, which was around $1 billion, and it was recorded as just $349 million. Some of this was because of your garden-variety seasonality. Current account deficits usually decline from September to October. However, even when we look at the seasonality-adjusted numbers, it is clear that there was a remarkable improvement in October of roughly $1.2 billion. So, even though the seasonality-adjusted current account deficit of $2.8 billion is still $2.8 billion more than what we would like Turkey to record, considering everything that is happening right now, it is a surprisingly positive result. And there were a few reasons that made this happen.

First and foremost, as we telegraphed loudly in our last current account article, energy prices declined significantly for both oil and gas, and this resulted in a noticeable improvement in the goods balance.

But even if we leave out energy and gold, there is still some improvement there.

We think that is partially because of the boom in capital goods exports, which is nice to see…

…and some compression in capital goods imports, which is not that nice, as this is a leading indicator of industrial production, and it has been weakening for a while. (However, the latest October figure was not that bad. There have been various divergences in industrial production coincident indicators lately like capacity utilization, PMI, SAMEKS, and Real Sector Confidence Index, so it’s a bit difficult to see where we are headed in that field, but this capital goods imports figure is another relatively bad sign for it.) The rest of the change in the Net Goods Exports ex-Energy and Gold came from price changes.

Another bad sign for the future is that, as thankfully flagged last time by Ertunc Aydogdu, because of the appreciation of the Lira in real terms (both inflation and income adjusted), consumption goods import volume rose significantly year-to-date, and we think this trend will continue after the wage hikes at the end of the year. In our previous article, we said we expected the minimum wage to be hiked to 8000 TL, which brings the real effective exchange rate by wages figure right back to where it was in 2017 and the sort of “breakeven” point of the USDTRY exchange rate where the 2019-2020 levels of REER can be had is around 21 TL/USD. We don’t think Lira will depreciate to that point as we wrote last week:

“[…] because the government apparently wants to lower the inflation as much as they can until the election while engaging in some election-spending and enacting some populist measures required to win the election, so they don’t want the impact of FX increasing the burden there, as it is abundantly clear from Minister Nebati’s latest speeches.”

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The realization that the exchange rate will be kept stable was one of the key changes from our last current account report in this one. That’s why we assume a roughly 4-billion-dollar impact from the increase in consumption goods imports in 2023.

Another key change from the last report to this one is that tourism revenues recovered to where they were in August after a relatively surprising drop in seasonality-adjusted terms in September, because of exceptionally warm weather in October, and a rise in the per-tourist spending. The latter might have a thing or two with the better data compilation methodology for tourism data that was initiated recently. In the previous version of the methodology, the data was basically from a survey. In the revised one, CBRT uses a whole host of additional data like tourist credit card spending, etc. We can’t know for sure, but the drop in the Net Errors and Omissions from an average 2-billion-dollar inflows to just 660 million in October makes us think that this is the case. We expect a relatively strong figure for November as well in seasonality-adjusted terms in travel revenues. And both because the beginning of the year saw some residual impact of Covid so it was not until mid-Summer that foreign tourist arrivals caught up to their 2019 levels and because of the recent reopening in China, we expect the total net travel and net transportation revenues to be 10 billion dollars more in 2023 than 2022. (Though the latter factor accounts for only 500-750 million dollars of this forecast, it’s not nothing either.)

As we said above, we observed precipitous declines in both oil and gas prices in the last 3 months. Brent crude oil declined below 80 dollars…

…and Russian crude, which Turkey buys a lot of right now, thereby helping the global oil prices stay stable along with China and India, sells for steeper and steeper discounts.

We expect 2023 prices to average around their current levels except for some possibly chaotic period when Europe stops buying Russian diesel, which translates to around 16 billion dollars in gains for Turkey in 2023 compared to 2022 in crude oil and diesel imports alone. (You can check this piece for further details on Turkish crude and oil product imports.)

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We expect natural gas prices to remain at their current high levels because as things stand right now, we think Europe will end this winter with about 20 percent of its natural gas inventory, so that means Europe will have to fill its inventory once again next year, but this time without Russian pipeline flows, which will be tough. We don’t expect prices to truly skyrocket like it did this year because of a very disorganized inventory filling period, but it will probably not be before 2026 that we will observe veritably normal natural gas prices.

However, thankfully Turkey imports around 70 percent of its natural gas via oil-indexed contracts, and once again, thankfully, oil prices declined significantly. Because of the 6-3-3 price structure in the oil-indexed contracts, (for more detail on this, please see our previous article on the current account balance) it will take a while for the decline in oil prices to passthrough to Turkish gas import prices but it will have an impact eventually and we estimate that effect to be nearly 2 billion dollars in 2023 compared to 2022. In March 2023, Turkey will start using its Black Sea natural gas and the initial production will cover about 6-7 percent of Turkey’s annual gas consumption. Because this will directly displace spot LNG imports, which is the most expensive type of natural gas Turkey imports right now, Black Sea gas will chip away 4.75 billion dollars from the natural gas import cost Turkey paid in 2022. All in all, we expect Turkey to pay 23 billion dollars less for energy in 2023.

[Noticed how the numbers regarding impacts were a lot smaller when we talked about huge and complex issues like competitiveness but they got much, much bigger when we started to list energy price-related effects?]

So in sum, we expect the 2023 current account deficit to be around 25 billion dollars.

If we breeze through the capital account (or the financial account as the cool kids call it nowadays), we forecast a net direct investment inflow of 7 billion dollars, and more than half of this will continue to be from real estate investments. That’s where the plateau seems to be in recent years. We are relatively pessimistic regarding portfolio flows and expect 9.5 billion dollars of net outflows, which is on par with the movement in 2020, as the Fed and other global central banks are holding onto their hawkish stances and it’s an election year in Turkey. And we expect 15 billion dollars of net inflows from other investments. The net inflows from this account amounted to 31.5 billion dollars year-to-date and 21.7 billion dollars in 2021, so once again we think this is relatively pessimistic. Last but not least, we reckon that we will observe roughly 5 billion dollars of net errors and omissions inflows. (12.6 billion dollars of net inflows were recorded in this account in the last 12 months.)

Our list of expectations so far puts the expected FX reserve decline at 7.5 billion dollars. Considering that the reserves are on a tear right now, there are a couple more bilateral deals in the pipeline with the likes of Saudi Arabia that would further bolster reserves, and that CDS is in decline, we think CBRT can keep the exchange rate stable if it wants to, in 2023, at least until the elections.

[Confusion Interlude: Recently there has been a lot of talk about the possibility of bilateral deals of CBRT coming with strings attached and being temporary. We found this perplexing. All money comes with strings attached. When some elderly blonde person residing in the White House threatened to collapse the Turkish economy 4 years ago, money that belonged to that country’s citizens and its allies left Turkey hastily and that money belonging to “people” rather than states did not change anything one bit. And as Jon Sindreu put it brilliantly in his latest piece, “Investors shouldn’t make the mistake of thinking such arrangements can’t last just because they aren’t market-based”]

We’d strongly prefer that they chose to accumulate some more reserves that would help lower CDS further while helping with the competitiveness of the Turkish economy, but as we said in our last article, that does not seem to be the approach the government will be taking.

Absolutely Essential Disclaimer: As any forecaster who publicly releases his/her forecasts knows, this is a thankless job, as the odds of your forecast turning out to be completely accurate are infinitesimal. One accepts this reality and moves on. However, we have to make something clear, not to cover our rears but to situate this whole piece properly: This is our baseline forecast. That means we think it is the likely path the future will take. It does not mean that it’s the only path the future can take. There are paths that force CBRT’s hand significantly and there are paths that help it accumulate a staggering amount of reserves in 2023. One such path is if Russia accepts Turkey’s proposal to apply a discount of 25 percent for its natural gas exports and postpone the payments to 2024. This is certainly possible, but it is not in our baseline forecast because we think it’s not a part of the “most likely trajectory of future events."

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Here's that big picture in a sentence: Inflation in Turkey has been spectacularly bad, it is still remarkably bad but better than before, but it seems to have plateaued at that “bad” level. We seasonality-adjusted more than 90 4-digit NACE code CPI components and constructed a seasonally-adjusted CPI series. The chart below shows the monthly percentage change in that. During the worst bouts of inflation, we saw more than 14 percent monthly increases, thankfully it did not stay there and for a while, it seems to have stabilized around 3 percent, which corresponds to a 41 percent year-over-year annualized increase. Not as bad as before, but still pretty bad.

The reason why we seasonally adjust everything in this article is to get rid of the seasonal factors that make it hard to do month-to-month comparisons and extract the underlying trend so we can extrapolate our findings into the future so that we can get a better understanding of the path CPI figures will likely take. But doing just that is usually not sufficient for that purpose because there are usually outliers that might affect the headline number but might not necessarily keep going in the same direction and magnitude. And that seems to be the case when we check the dispersion in the CPI basket. The chart below shows the year-over-year trajectories of various percentiles. (That is, it selects the product group that corresponds to that percentile each month and constructs an index and calculates YoY % changes. The 90th percentile selects the 9th product group that showed the most increase each month and the 10th percentile the 82nd out of 91 product groups.)

As it is abundantly clear, there are some product groups in the basket that had mind-boggling price increases in 2022, and there are some that had pretty “meh” paths. That’s why taking a look at the Trimmed CPI we calculated, once again using seasonally-adjusted data, might be more appropriate to get a clearer read on the underlying trend. It “trims” out every product group above the 85th percentile and below the 15th percentile each month.

And here it is in YoY terms:

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It looks much better than the headline CPI figure in November, 84.39%, and it is not surprising that it does. Energy prices, which constitute a significant chunk of the CPI basket, were hugely affected by the Russia-Ukraine War, causing some outlier-level MoM changes especially early in the year. While it is certainly possible that there might be similar and significant shocks in 2023 (we learned to never rule out the possibility of something bad happening, ever since the pandemic), we think Trimmed CPI provides a much clearer picture regarding the overall inflation mechanics.

One other way to analyze those mechanics is to take a look at inflation inertia. It basically measures what would the inflation be if “nothing happened”. In some respects, it is obvious why this matters, but we care especially because it is a key figure in discussions about the competitiveness of an economy.

It essentially shows how much the currency of a country needs to depreciate to keep the real effective exchange rate constant. And it is a lower bound because there will be some passthrough from the depreciation itself. So, it is probably the most important inflation metric we track, because (though this example will sound absurd, bear with us) if an economy has an 80% CPI but 0% inflation inertia, that means policies aimed at reducing inflation can basically work instantaneously by removing the causes from the picture but if the inflation inertia is 80%, policymakers can do pretty much nothing in the short-term. (Or better put, whatever they do will take a long while to bring the inflation down.)

It is not a constant number, it changes constantly, so we treated it as such. The chart below shows the historical annualized inertial inflation figures.

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The latest figure for November is 35.87% but the estimation is based on a rolling 12-month window, so we think the latest instantaneous figure is roughly 29 percent YoY. And this is, once again, clearly bad.

A lot of factors affect inertia like backward indexation and if the pricing behavior in that country is anchored or not. (Though if the inertia is 29%, it’s evidently unanchored.) So, if policymakers manage to do a good job with other factors affecting inflation itself or the global economic environment is favorable, inertia will come down over time as well, which is what happened after 2003. But as things stand, 29% is the mountain to be climbed.

The chart below shows the culmination of these three metrics: The CPI path they predict until the end of 2023, assuming that they stay constant until then.

The path of inflation inertia might look a bit rosy, and that’s because it is. Remember, we said it is where CPI would be if nothing happened. No Lira depreciation, no import price increases, nothing. But of course, “some” things will happen, instead of nothing. So, let’s briefly analyze what would those things be. (Briefly, because some of these things deserve a separate article that we will write in due time.)

1.        Exchange Rate: We think CBRT has the means to keep the Lira on an extremely mild depreciation path, as portfolio flows, the current account, and bilateral relations with a host of countries are improving, and there has been a roughly 12 billion dollars increase in reserves, excluding swaps and Treasury cash, in the last 2 months. The question is, will they choose to do so. We think the answer is yes because the government apparently wants to lower the inflation as much as they can until the election while engaging in some election-spending and enacting some populist measures required to win the election, so they don’t want the impact of FX increasing the burden there, as it is abundantly clear from Minister Nebati’s latest speeches.

2.       Energy prices: We think natural gas prices will remain high and oil prices will remain at their current levels. There is a chance of a small decline in domestic natural gas prices after the inauguration of the Black Sea natural gas but we think it’s not extremely likely. (We will talk about Black Sea gas in a separate article.)

3.       Rents: We expect some impact from this as the cap on rent hikes will expire at the end of June and a new cheap mortgage loan package is a possibility, though we expect it to target first-time buyers and be small in scope.

4.      Remember we mentioned some populist policies to be enacted? This is the big one. [AND WE HATE THIS.] It is strongly likely that a law allowing roughly 2 percent of the labor force to retire early will be passed in early next year with the support of both the opposition and the government, and some government officials mentioned a commercial loan package backed by the Credit Guarantee Fund might be in the cards to help firms weather this. This will have a relatively major impact both because of the loan package and the huge amount of retirement bonuses to be spent in a short amount of time. [Have we told you about how much we hate this? Better safe than sorry: WE HATE THIS, PASSIONATELY.] We plan to write further about this some other time.

5.       Minimum Wage Hike: We expect the monthly net minimum wage to be increased to 8000 TL which would amount to an 88 percent increase year-over-year, though only 45 percent since the last hike in July. We forecast it to have a sizable impact as well. However, we have to make this distinction: It is not the wage hike itself that will have the impact. It’s just that it will allow firms to hike prices while having the wage hike as an excuse, as they already increased their profit margins beyond the level that can compensate for the wage hike. Because that’s what “unanchored pricing behavior” is: Firms not needing to think twice before increasing their prices.

As a result of these factors, we forecast the end-of-2023 Turkey CPI figure as 35 percent. We will let you know if any crucial changes occur in the elements of this analysis.

We would like to apologize for this article arriving a bit late due to some health issues. To make up for it, we will publish two more macro pieces this week. So, until then, have a great rest-of-the-week!

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Debit & Credit Card Expenditures

We think that tracking credit card data in dollar terms is important for more accurate comparisons. However, one year ago during this period, there was mind-boggling volatility in the USDTRY exchange rate. Therefore, for at least these couple of weeks it is better to focus on which sectors are doing better than others, rather than the level of change but in general, it is obvious that domestic consumption continues its strong course.

For those who don't understand what we mean by “mind-boggling”, the chart of the USDTRY rate is the following:

From Bloomberg

One month implied volatility for USDTRY:

From Bloomberg

If we look at the credit card data, we see that insurance, restaurants, clothing, and accommodation expenditures are strong. We explained our views on clothing expenditures in detail in our previous markets post. Moreover, we think that discount campaigns in November supported household spending in some categories like clothing. We are eagerly awaiting the third quarter results of Mavi Giyim, which will be announced on 12 December.

Sectoral Export Data

Turkish Exporters Assembly (TİM) announced the sectoral export data for November. We look at the annual changes in some sectors we chose.

Source: Turkish Exporters Assembly (TİM)

Fruit and vegetable products maintained their positive momentum despite the slight slowdown monthly. Looking at the sub-categories, we see a strong increase in the export of canned products (+37% YoY). We estimate that the positive trend in tomato paste exports continues in November. In addition to the tonnage growth, the unit value of tomato paste has shown a very strong increase in the recent period. (The value per ton, which was 1090 dollars at the beginning of the year, approached the 1900 dollars level in October.) This data is positive for tomato paste producers such as TATGD and TUKAS.

Source: Turkstat

The textile category continued to remain in the contraction zone this month. Looking at the sub-categories, the largest decline was observed in the yarn category (-19% YoY) which affects the headline the most. We have drawn attention to some potential risks for yarn producers in our previous markets post.

Steel exports drastically declined amid rising costs and weak demand. It becomes apparent that the growth in the chemicals category began to slow down.

Leather and automotive categories gained positive momentum this month.

In the first 11 months of the year, exports increased by 14% compared to the same period last year, while exports increased by 2% on an annual basis in November. We can say that lower demand in export markets and declining competitiveness will continue to challenge exporters despite some sectors posting strong growths. We should be quite selective when talking about the exporters.

PMI Data

The headline PMI fell to 45.7 in November and remained below the threshold of 50 for the ninth month in a row. In line with our expectations and other data releases, many sectors are in the contraction zone in November. Textile and steel have long been below the threshold. Clothing, on the other hand, has a positive outlook here as well.

Source: Istanbul Chamber of Industry (ISO)

Weekly electricity generation data (MWh), which is the leading indicator for economic activity, is also not very good in recent weeks compared to last year.

Source: CBRT

TUPRAS’s November Margins

This week, TUPRAS’s margins (Turkish refinery) were announced. In one of our previous posts, we made evaluations on petroleum products and especially on the diesel market in Turkey. Diesel margins are particularly important for the company due to the high share of diesel in the company's sales. Although the company's diesel margins fell on a monthly basis, they remained well above their historical averages.

From Tupras’ investor presentation

We should say that these times are quite exceptional for this market and these margins cannot last for years. Our humble perspective is that no one should invest on the assumption that these margins will last forever. Consider the margin cycles, please. Some caveats should be made even for long-term investors. Where are we in the margins cycle? Not anywhere near the bottom for sure.

Our question is that how long can margins stay at these high levels in the global diesel market? What developments should we monitor?

i) Russian Sanctions and European Needs: Some of the diesel supplied by Russia disappeared from the market in 2022. Furthermore, the EU will ban Russian oil product imports (including diesel) by February 5. Where this ban will evolve and to what extent other regions will be able to compensate for the deficit will be important. Before the ban, Russian diesel loadings going to the Amsterdam-Rotterdam-Antwerp (ARA) storage site increased by 126% in the first 12 days of November, compared to the previous month. EU diesel imports from non-Europe/non-Russian sources increased substantially. Europe is more likely to be ready for the sanctions than we think. At the start of the year, there were estimates of additional diesel demand from Europe for heat and electricity generation. Nothing significant materialized so far. Economic slowdown and weather conditions helped a lot. We will monitor how weather conditions and sanctions on Russia will affect the market for Europe. Economic activity will be also important for the demand conditions.

ii) Chinese Refineries: China has considerably reduced its exports of petroleum products in 2022. This has reduced the global diesel supply. However, recently, there have been reports that refineries in China have increased diesel exports to profit from robust margins. If this situation continues strongly, it may have positive effects in terms of supply, especially in the East-of-Suez. It will help to boost East-of-Suez flows to Europe (indirectly) because, in the absence of Chinese products, East-of-Suez flows should go further east to some extent (at the expense of supply for Europeans).

iii) Gas Crisis: If you know the distillation process in general, you know that the crude quality used in the process is quite important for the refining results. This year, higher natural gas costs created incentives for more usage of sweeter crude oil. To reduce their natural gas usage, the refineries preferred light sweet crudes that require less desulfurization. Light crude oil yields more gasoline but less middle distillates. This reduced diesel output and increased its cracks. It also increased gasoline output and decreased gasoline cracks. It will be important whether there will be a change or not on this front in the upcoming period.

From U.S. Energy Information Administration

Based on these factors, it is a probability that we can see a further increase in margins, or it will remain at these elevated levels for some time but we think that the probability for the opposite scenario should not be underestimated, especially for the first half of 2023.

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

This article will be on why implementing such a policy is a structural reform for the Turkish economy, and what were the results of similar policies implemented elsewhere on earth. Thanks to our readers, we think we have a platform on which we can speak about such issues, and we think it is our responsibility to do so.

One of the things free school lunch programs reliably do all over the world is that they increase the probability of kids from lower socioeconomic backgrounds attaining school, especially in rural regions. Rural parents with little to no economic means are often in a dilemma: You can put your kid in school where s/he “might” get a chance to make his/her own future but s/he will be a huge financial black hole for 12 years or s/he might start working or helping with things in the house and lose that chance but not be an economic burden either, and for a lot of people, the state bearing the cost of the meals might be the difference between their kids going to school or not. Now Turkey legally requires sending one’s kids to school for primary education and there are exorbitant fines in place for incompliance, and according to the OECD statistics, it has a 100 percent enrollment rate for the first 8 years of schooling. The problem is, although anecdotal, we know that there is a huge issue of kids missing some parts of the school year in rural regions as those parts coincide with the sowing and reaping seasons. So, we think, as in other countries where free school lunch is implemented, Turkey would benefit from a higher educational attainment level in lower-income parts of the nation.

Let's get one thing out of the way: we don't think education is a crucial piece of the developmental puzzle, we don't think it is one of the primary causes of economic growth despite what many economists and lay people think, and we would strongly argue that it is a result of growth more than a cause. In no country we know, we can observe a higher level of overall educational attainment preceding a higher level of per capita income and wealth. In fact, we think higher spending on education than what is warranted by the living standards in a country before a country has the sufficient industrial capacity that can benefit from a high level of educational attainment is not that dissimilar to being a doomsday prepper producing your own food while not owning a gun because as Bill Burr puts it, the only thing you're doing by that is gathering supplies for the toughest guy in the block, and you’re effectively subsidizing the workforces of Europe and the US with taxpayer money.

[We do realize this sounds a bit harsh, but it is what it is. Unless you’re China and a hundred thousand people going to the US after graduation every year is not that big of a deal because if even thirty thousand of those people come back home after getting their master’s degrees or PhDs, you’re fine, that is.]  

And while books worth of things can be said about the ways to create such industrial capacity, and we plan on saying those things in future Galata Chronicles articles, let's just say mass education is not one of the key ingredients. One of our favorite papers on this issue puts it succinctly, albeit wonkishly:

“While there is undeniably ample intuition and theoretical support for the importance of human capital in growth specifications, we fail to find robust empirical support for the inclusion of human capital as proxied by mean years of schooling in our baseline growth regression specification. […] We fail to find adequate empirical support for the statistical significance of mean years of schooling. Rather, we find that, in general, estimates of the impact of mean years of schooling bear little statistical significance in terms of the estimated partial effects and a formal nonparametric test of variable relevance.”

That said, economic growth is not an end-all-be-all goal, and there are many other things that should be in the objective function of a government like the health and safety of its citizens, people's overall level of happiness, and their ability to lead meaningful lives. We are not saying that the government should be a nanny and cater to every single one of its citizens’ needs. We are just saying the government should be trying to create a level playing field that would enable its citizens to achieve their own goals and dreams. And in this regard, kids from low-income households not missing school for months on end should be an unequivocal win.

Despite this little “Pursuit of Happiness-esque” disclaimer, there are very real, tangible, and likely material economic benefits that will probably accrue as a result of a free school lunch program.

There is a large and growing literature about the impact of cognitive abilities on economic development. Another one of our favorite papers is quite clear on the subject:

“This paper […] concludes that there is strong evidence that the cognitive skills of the population—rather than mere school attainment—are powerfully related to individual earnings, to the distribution of income, and to economic growth. International comparisons incorporating expanded data on cognitive skills reveal much larger skill deficits in developing countries than generally derived from just school enrollment and attainment.”

Now there are way too many factors that go into the formation of cognitive abilities, but one factor that is definitely in there is nutrition. Children in developing countries more often than not have a diet that is not conducive to cognitive growth, their diet is usually low on protein and fruits and includes way too much junk food. Turkey is no exception in this regard and somewhat puzzlingly even well-off kids have a bad diet. (In fact, rich kids apparently consume more junk food than their low-income household peers, which actually helps our argument because this means a non-means-tested, universal free school lunch would get us a lot of bang for our buck. A significant number of rich kids would effectively self-select out of the program as they go to private schools anyway.) And childhood obesity seems to be a raging problem. So, providing a lunch that is healthy, rich in protein and essential micronutrients would go a long way in increasing the cognitive abilities of Turkish kids, and it would once again level the playing field as research indicates such programs help poor kids’ nutrition quality more and allow them to achieve better outcomes. [Ideally, the program should extend to preschools where children's brain development is at a much more critical stage and while we’re at it, the number of preschools should be increased rapidly.] Lower future healthcare costs associated with better health outcomes that would ensue as a result of this program would only add to the material economic results. And research indicates that not only the child who will be consuming the actual food, but also his/her kids and grandkids benefit from this intervention, which further supports our argument that free school meals are not palliative, but structural reforms.

Not only would this program would help with physical health and cognitive development, but some studies indicate that it might help with behavioral development as well, by reducing anti-social behavior, which is associated with better outcomes in the labor market.

To make sure policymakers reading this piece have a higher likelihood of supporting this scheme: It would be WILDLY politically popular. This government decided to give schoolbooks for free around 20 years ago and people are still talking about it. Imagine what would happen if you give kids free food, fellas.

Anyway, in conclusion, we think there is ample evidence out there as to the efficacy of free school meals in various critical regards and we think it is definitely one of those “structural reforms” people love to talk about all the time but fail to come up with something concrete when questioned. We are sure that it will survive the cost/benefit analysis currently in progress, but we would love for you to share this piece to make more people aware of the importance of its implementation.

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In this post, we want to make some highlights about the textiles and ready-to-wear sector (considering the aforementioned dynamics). Then, we will look at why Mavi Giyim (MAVI) has attracted our attention.

Producers vs. Retailers

We can classify the companies in the textile and ready-to-wear sector as i) producers/manufacturers, and ii) retailers. There are significantly different dynamics for these two types of companies, and it is quite important to take these different dynamics into the consideration when making investment decisions. To put our view forward first, in the coming period, we think that retailers will be in a more advantageous position than manufacturers/producers.

Here are our reasons:

One of the main differences is that while the producers/manufacturers in the textile and ready-to-wear sector are mostly export-dependent (it produces above the needs of the domestic market, so they need the positive outlook abroad), retailers (such as MAVI, and VAKKO) are overwhelmingly selling to the domestic market. Under current conditions, which side has more advantages? To understand, we can look at two different data.

Firstly, if we look at the exports of textile and ready-to-wear companies, it is obviously losing momentum.

The problems in economic activity in Europe (the biggest trade partner, for textiles, its share is around 44%) are quite harmful for such a sector that produces above the needs of the domestic market.

In addition to the negative economic outlook in European countries, as we emphasized in our last macro post, because the exchange rate is relatively stable in the recent period, while there is a huge amount of price inflation in Turkey, the competitiveness of Turkish exports eroded to some degree. The PPI-based Real Effective Exchange Rate exceeded the level of 90 for the first time since June 2017. We have mixed thoughts and feelings about that rise because we cannot predict how long it will remain at these elevated levels while entering the election year (the clear focus of policymakers on inflation and USDTRY). We cannot predict how long it takes to make a balance between inflation/FX rates, and the current account balance dynamics. There is a clear choice about exchange rates now. Some respite in REER may be needed.

(From our last macro post)

According to news from sectoral sources, in the textile and ready-to-wear sector, large buyers turned to other regions for supply instead of Turkey because of rising costs. A decrease in freight cost is also important in that respect. According to that news, Inditex, the owner of the world's largest fast fashion brands stated that it will increase its purchases from Asia and reduce from Turkey. Industry representatives stated that the imports are now becoming more attractive even for local brands such as LC Waikiki, DeFacto, and Koton.

Another important development is that the ban on Uzbekistan cotton which has been implemented by more than 300 global brands since 2011, was lifted as of March 2022. Uzbekistan has been boycotted since 2011 by famous brands such as H&M, Adidas, and Marks & Spencer, due to poor cotton production conditions and child labor usage. However, with the reforms made in the country, the cotton export ban was finally lifted. Why is it important? It means that the world's sixth-largest cotton producer will return. It once ranked as the second country in cotton exports. The return of Uzbekistan facilitates the country’s textile sector-oriented growth strategy. It is stated that the country’s aim is to turn from a cotton producer into a textile and clothing exporter country. Reportedly, new textile manufacturing sites were established in the country in the last few years. As of September, the import of cotton, cotton yarn, and cotton textiles of Turkey increased by 55% YoY in USD terms (exports increased by just 5 percent). The return of Uzbekistan affected it as well. The foreign trade deficit in the yarn category and the falling capacity utilization rates in that category increased the concerns. While the return of Uzbekistan will increase the supply of cotton-made intermediary products in the world, please consider the PPI-based real effective exchange rate in Turkey. Alerts for Turkish yarn producers.

Therefore, to conclude, the overall outlook for producers/manufacturers in that sector seems mixed, and a bit negative.

Secondly, let’s look at the retail side. CBRT published the debit & credit card expenditure data for the week ending 11th November.

As you can see, the clothing & accessory category posted strong growth YoY in USD terms last week. It even gained momentum recently. From the longer time horizon (52-week) to the shorter one (the last week), it seems this category has a healthy growth this year. This data shows that the domestic demand for ready-to-wear retailers is strong. Well, what should we expect? We think that this positive momentum will continue, if not increase.

i)                 People in Turkey still think that the high inflation environment will persist for a while (even if the base effect will kick to some degree, CPI will only slide down to the low 40s YoY). They try to front-load their demands right now. On the other hand, compared to durable goods such as white goods or furniture, ready-to-wear items are more affordable under these conditions.

ii)               We expect that the minimum wage will be increased substantially in 2023 before the elections. It will increase the appetite for more shopping. It will return more sales for the retailers.

iii)              The outlook in export markets is less relevant for Turkish ready-to-wear retailers because they are less export-dependent compared to the producers.

To conclude, we are more optimistic about retailers in the coming period under current conditions.

Mavi Giyim (MAVI) Has Tailwinds

If you have been following Turkish markets, you are familiar with Mavi Giyim (MAVI). Mavi Giyim was established in 1991 in Istanbul as a denim-centric ready-to-wear company and has been publicly traded since 2017 in Borsa Istanbul. Mavi’s line of business includes the wholesale and retail sales of ready-to-wear apparel to customers. The company does not engage in any production activity. Its diversified supplier network manufactures the products and makes them ready for sale. This supplier network includes more than 120 main suppliers and 485 sub-suppliers (80% of them located in Turkey). In the production process, the apparel’s design & development phase is directly performed by Mavi itself. In addition, the selection of fabric & raw materials is controlled by the company. After these processes, the phase of production (cutting, sewing, and washing) is delegated to the manufacturers.

Without going into more details about the company, we would like to draw attention to a few points that can be important in the coming period.

1. As we see in the credit and debit card expenditure data published by CBRT, the outlook for the clothing category is quite positive right now, and we think that Mavi Giyim can capture these positive dynamics. The company has a unique brand image in the denim category. According to the survey results of Marketing Türkiye Magazine, in the denim category, MAVI is a top choice in the preference ranking of different generations. The magazine stated that there is no competition in denim, there is a strong leader.

2. The share of exports in the company’s total sales is below 20 percent. All the aforementioned headwinds in the export markets have limited impacts on the company’s financials. The momentum is positive in the domestic market. Moreover, the company can offset the negative outlook in export markets to some extent with its strong brand image.

3. As the CEO of the company stated in the first quarter financial results webcast, the price of cotton is quite important for the company. The margins are more dependent on the prices of cotton and fabric (rather than wage increases, therefore, the impact of a high minimum wage increase may be limited).

   

   (From the earnings call transcript of 1Q22)

   From its peak in May 2022, cotton prices started to decline. It's still 36 percent below that level. It will affect MAVI’s COGS and gross profit margin. But, again, as the CEO said, there is around a six-month lag in terms of cost reflection. We will see the impact of that decline in the last quarter of 2022 (slightly), and the first quarter of 2023 (especially here).

   

   (Bloomberg)

4. We expect that the substantial increase in minimum wages will further drive consumption up in Turkey, which is positive for MAVI. We also expect that the high consumer demand will result in very high sell-through rates and lower markdowns, as in 1Q 2022. Lower markdowns will support the margins.

   NOTE: Typically, fall-winter products have lower gross margins by design. They are more import-dependent, and they are less made in Turkey. Because of that, the management team of the company was more pessimistic about that period (seen in transcripts). Therefore, normally, it is appropriate to expect lower gross margins in the last and first quarters. However, this time, the impact of lower markdowns (if happened) will support the margins. All in all, there could be slight margin erosions.

To conclude, the macro environment seems to be positive for ready-to-wear retailers, compared to the producers. MAVI is one of them and is a powerful player in its segment. It will announce its third-quarter result on 12th December. Our revenue forecast is the following:

We did not value the company here but we can say that Mavi Giyim has clear tailwinds.

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

According to data from the Central Bank of the Republic of Turkey, Turkey’s current account balance posted a deficit of $2.97 billion in September. [Our latest macro post was about short-term dynamics of Turkish current account balance – G.C.] – BloombergHT

Turkish Statistical Institute (Turkstat) announced industrial production data for September. Accordingly, industrial production fell by 1.6 percent on a monthly basis, more than the forecasts. On an annual basis, it increased by 0.4 percent, thus recording the weakest increase since the pandemics on an annual basis – BloombergHT

Construction cost index increased by 1.57 percent on a monthly basis and by 119.83 percent on an annual basis in September – TRT Haber

According to the data published by Turkish Statistical Institute (Turkstat), the unemployment rate rose by 0.3 points to 10.1 percent in September. Thus, the unemployment rate, which fell to 9.8 percent in August for the first time in 4 years, went back to double digits – BloombergHT

According to the data published by Turkish Statistical Institute (Turkstat), retail sales volume increased by 9.7% annually, by 1.8% monthly in September. Retail turnover increased by 130.8% annually, 5.0% monthly in that month – BloombergHT

According to the data announced by the Istanbul Chamber of Industry (ISO), the Manufacturing Industry Export Climate Index decreased to 47.9 in October – TRT Haber

Budget cash balance, which gave a deficit of 79.3 billion TRY in September, gave a deficit of 72 billion TRY in October - BloombergHT

In the first 10 months of this year, total automotive production increased by 5 percent compared to the same period of the previous year, while automobile production decreased by 0.3 percent – Dünya

The mandate of the Patriot missile defense system stationed in the province of Adana, which Spain sent to contribute to Turkey's air defense, was extended until June 2023 – Dünya

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Source: Galata Chronicles’ calculations, CBRT (Last Observation: September 2022)

Eurocontrol data suggests that this remarkable performance in air travel continued, nay, got even stronger in October and November, so we might expect further increases in seasonally adjusted transportation revenues in the upcoming BoP releases. The chart below from Eurocontrol shows the daily number of flights into/from Turkey and compares them to the 2019 levels.

Source: Eurocontrol

Meanwhile, net travel revenues seem to have stopped its rapid ascension for now and declined by roughly 500 million dollars compared to the August results (seasonally adjusted), which was mainly due to the decrease in the number of tourists while the per-tourist revenue was flat. And the General Directorate of State Airports Authority (DHMI) figures for October suggest that the relatively underwhelming, but still above the all-time highs, travel revenue trend continued in October as well. Some more hopeful news came from Antalya, and we learned that tourist inflows to Antalya stood at an all-time high in October, so perhaps we’ll observe a better October travel revenue figure in the BoP than DHMI numbers suggest. But it is probably not a stretch to say that the 5-6 month breathtakingly good episode of Turkey adding more than 5 percent month-to-month to its seasonally adjusted tourism revenues ended for now.

Source: Galata Chronicles’ calculations, CBRT (Last Observation: September 2022)

In sum, the evergreen story of Turkey funding its goods deficit with its services surplus continued in September. And about that goods deficit:

Source: Galata Chronicles’ calculations, CBRT (Last Observation: September 2022)

OK, that looks pretty bad. But if you have been reading us for a few weeks now, you should be asking “Sure that looks bad, but remember, Turkey is an energy importer, energy prices are at an all-time high, so what’s the picture if you remove energy imports?”. Well, excellent question, dear reader. We will do you one better and remove net gold imports as well, to see how things are going in the “core” goods account. It turns out that it’s not nearly as bad as the chart above, but it’s not great either. Even if you remove gold and energy, there is a clear worsening in the core trend.

Source: Galata Chronicles’ calculations, CBRT (Last Observation: September 2022)

The main issue seems to be, because the exchange rate is relatively stable while there is a huge amount of price inflation, Turkish exports see their competitiveness erode. The chart below shows that the PPI-based Real Effective Exchange Rate is nearly back to its 2017 levels, because of the stratospheric rise in the PPI, which we don’t forecast to keep on going in 2023, so perhaps the usual path of depreciation in the Lira in the next 1.5 years will provide some respite here to the tune of roughly 7-8 points. One other potential problem is, Turkish exporters benefited a lot from the skyrocketing freight prices in the last year or two, but freight prices are collapsing globally, so it remains to be seen if they can keep the markets they gained in this period.

Source: CBRT (Last Observation: October 2022)

We have to note that the picture in the CPI-based REER is a lot different, and the level is stagnant for quite a while, so we expect the depressed levels of consumer goods import to continue for the near future, though the wage hikes at the end of this year might be a tailwind there. Despite all this, Turkey has roughly 2-3 billion dollars of ex-energy and gold seasonally adjusted current account surplus, and if energy prices stayed at their 2021 levels, Turkey would still be enjoying a current account surplus on average. That means we need to look at the more unstable part, which unfortunately constitutes a large chunk of the Turkish BoP picture: Energy. (We know we shared this chart in a previous article but it wouldn’t hurt to save you a click, would it?)

Source: Galata Chronicles’ calculations

Let’s get oil out of the way first, because we talked about it in depth in our last macro article: because of the Urals discount, we expect that the price Turkey pays for its oil imports will stay largely stagnant for the next 4-5 months, as we expect the discount to balance the impact of the higher diesel prices to a large extent, since the more effective the EU price cap and import ban, the higher the European diesel prices but lower the Russian oil prices. (Probably)

That leaves natural gas. The good news is, Turkish natural gas imports are at the lower edge of the last 3-4 year consumption patterns.

Source: Galata Chronicles’ calculations, EXIST (Last Observation: October 2022)

There are two reasons behind that. The first one is temperatures. Turkey, like Europe, has seen temperatures 2-3 degrees above the seasonal averages. Our estimates show that a single degree makes a difference of about 100 million cubic meters, though this is not a constant figure, and the colder it gets, the better it is to have warmer than average temperatures. The chart below specifies this. And the latest meteorological forecasts show that the weather in Turkey will continue to help, with 1.5-2 degrees above normal temperatures in the next three months. (And the second reason, probably, is that natural gas prices increased 4-fold year-over-year for residential use, which constitutes the bulk of the seasonal variation in natural gas consumption, so there is a huge amount of price incentive to just wear a sweater inside the house and not consume gas as usual.)

Source: Galata Chronicles’ calculations

The second and obviously the more important component of the natural gas BoP picture is price. A couple of facts: Turkey gets roughly 70 percent of its natural gas with oil-indexed prices and the remaining part from hub-indexed ones, like spot LNG. (Actually, the oil-indexed share was higher until this year, but in January Turkey renewed a gas supply deal with Russia for about a quarter of its imports from Russia but switched from oil-indexation to hub-indexation, and if it didn’t it would have paid roughly 3 billion dollars less for gas year-to-date. Turkey for years wanted to switch to hub-indexation because gas-to-gas competition forced LNG to be a lot cheaper, especially in 2020, but right when it got what it wanted, Russia-Ukraine War happened, and well, you know the rest of the story. Talk about fate.) There is literally nothing publicly known about Turkish natural gas supply contracts except if they are oil or hub-indexed, but we at Galata Chronicles are a curious bunch so we spent days and days econometrically analyzing the available data and our conclusion is, Turkish oil-indexed gas import prices are roughly 30 percent of the 6-3-3 heating oil prices and hub-indexed prices are on average 94 percent of the TTF prices on a per-M3 basis. (6-3-3 is a gas market term and it basically means a rolling 6-month average with a 3-month lag. In the chart below you see our forecast for the Turkish natural gas import prices and a 70/30 percent weighted average for an indication of the total path. As it can be seen, import prices quite likely peaked in September and October, and thanks to the good weather in Europe that helped collapse TTF prices along with full natural gas inventories, Turkey will pay roughly 30 percent less for its natural gas in November compared to the September-October average. 

Source: Galata Chronicles’ calculations, Bloomberg

So overall, the energy part of the balance of payments equation will probably be a lot better in the next couple of months. That leaves gold and we prefer to not say a lot here because when we do, it usually contains a ton of expletives about the mind-boggling nature of still buying this much gold in 2022, so let’s just say Turkish people are on average hardcore goldbugs and we don’t expect significant positive news from this front anytime soon. Istanbul Gold Refinery data shows the amount of imports didn’t change much compared to September in October 2022.

Source: Galata Chronicles’ calculations, CBRT (Last Observation: September 2022)

In conclusion, while there are significant headwinds for Turkish exporters and energy prices continue to severely impact things, because of the still strong services exports and lower natural gas prices, we think the worst might be behind us in terms of the current account balance. At least for the next couple of months. If anything changes here, we will let you know.

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The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

In October, annual inflation exceeded 85 percent. According to the data of the Turkish Statistical Institute (TUIK), the consumer price index increased by 85.51 percent in October compared to the same month of the previous year. Monthly inflation was 3.54 percent. Thus, inflation reached its highest level in 24 years – Dünya

The Central Bank of the Republic of Turkey announced the real effective exchange rate for October. The real effective exchange rate index rose to 55.70 on the basis of CPI. The PPI-based real effective exchange rate index also reached its highest level since 2017 – BloombergHT

According to the data of the Central Bank of the Republic of Turkey, the net foreign exchange position gap of non-financial firms decreased by $2.02 billion month-on-month to $89.1 billion in August. The real sector foreign exchange deficit fell below $90 billion for the first time since 2010 – BloombergHT

The credit volume of the banking sector increased by 108 billion 183 million liras last week and reached 7 trillion 17 billion 723 million liras. In the said period, the amount of commercial loans with installments increased by 6 billion 844 million liras and reached 896 billion 423 million liras, while the interest rates fell to 18.3 percent – BloombergHT

The revaluation rate to be applied for 2023 was announced as 122.9 percent. The revaluation rate for 2022 was 36.2 percent. [The revaluation rate is applied to many goods and services and tax levels, and it is up to the President if the determined rate is applied without change or a lower rate will apply. - GC] – Dünya

The tax brackets will increase as the revaluation rate rises to 122.9 percent, nearly three times last year. If it is applied unchanged, the income limit for the lowest tax of 15 percent will increase from 2,666 TL to 5,916 TL per month, and the limit for the 20 percent tax will increase from 5,833 TL to 12,916 TL per month – BloombergHT

President Erdogan: Work is being done for the 3rd nuclear power plant, we will do it too – BloombergHT

According to the foreign trade statistics of October announced by the Minister of Trade Mehmet Muş, exports increased by 3 percent compared to the same month of the previous year and reached 21.3 billion dollars. Imports amounted to 29.3 billion dollars. The foreign trade deficit increased by 430.4 percent to 8 billion dollars in October – BloombergHT

ISO Turkey Manufacturing PMI index decreased to 46.4 in October. The index remained below the threshold value of 50 for the eighth month in a row, pointing to a sharp slowdown in the sector's performance. Thus, the manufacturing PMI fell to the lowest level since the pandemic. [Because of some weird calibration issues, the 0 percent growth threshold corresponds to 48 instead of 50 in our analyses, something to keep in mind. – GC] – Dünya

Bloomberg HT Consumer Confidence Index increased by 8.77 percent to 70.31 in October compared to the previous month. This was the highest level since January 2021 – BloombergHT

Cardboard Packaging Manufacturers Association (KASAD) President Alican Duran stated that the paper-cardboard packaging industry has faced significant challenges both in export markets and in the domestic market. Duran stated that the export orders of the sector are delayed by 2-3 months, while the demand in the domestic market has shrunk by 15 percent - Dünya

The Minister of Environment, Urbanization and, Climate Change, Kurum said, "We want to start a campaign that includes 100 thousand houses and covers all our cities, in this way, we will also activate the beginnings of new projects. We will announce it this month." – Anadolu Agency

Alfa Solar Energy’s IPO was approved. The company produces solar panels – BloombergHT

Turkey's automotive industry exported $2.65 billion worth of products in October – BloombergHT

According to the traditional guest satisfaction survey results of Tatilsepeti, 81% of 3219 participants stated that they took a vacation in 2022, while 98% stated that they planned a vacation for 2023. Moreover, 71% of the participants said that they will benefit from early booking opportunities in 2023 - Dünya

THY’s third quarter revenue reached 6.1 billion dollars, exceeding its total revenues in the same period of 2019 by 52 percent. In the third quarter, the net profit reached 1.5 billion dollars [THY met increasing passenger demand successfully, rising after the pandemic. - GC] – Anadolu Agency

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We will announce the best investment of this year, by far. It is Borsa Istanbul. Surprisingly, yes. The word “Turkey” is generally mentioned in the discussions about its monetary policy decisions in global markets. However, this time, Turkey should have attracted the attention with its stock market performance. The return of benchmark index (XU100) exceeded 60 percent in dollar terms year-to-date (from the close of the last trading day of 2021). Given the current performance of other stock markets, undoubtedly, Borsa Istanbul provides a good opportunity for both residents and foreigners. We left October behind, and a bunch of important data was released this week. In this piece, I want to make a quick overview on some of them.

A General Note

When we refer to the companies, we try to map the data. Regardless of the valuation of companies, we say it is positive or negative for companies. Maybe the news is positive but the company is overvalued/expensive. Maybe the company has other serious problems (cash flow, financing terms, etc.). These are different things. Keep in mind, please.

Sectoral Export Data

Turkish Exporters Assembly (TİM) has published the export data for October. We select most relevant categories to see the evolution of exports in key sectors.

In October, fruit and vegetable products gained further positive momentum YoY. Canned products contributed to headline growth the most (+76% YoY), which is positive for canned product producers such as tomato paste companies. These companies that sell essential goods attracted investors’ attention amidst current inflationary and recessionary environment. Evidently, cereal category also posted a strong growth. In this category, the vegetable oils affected the growth the most (+41% YoY).

This year, traditionally-strong sectors (having larger shares in Turkey’s exports) such as textile, apparel, automotive, steel have experienced significant fluctuations because of cyclicality. However, chemicals have posted strong growth. On the other hand, furniture, paper, and forestry sector stand relatively strong, and increased its export 15% YoY. If we look at the sub-categories, compared to furniture, the paper and cardboard segment has grown stronger.

The danger bells are ringing for steel, ready-to-wear, and textile sectors, at least in the export market.

Debit & Credit Card Expenditure Data

CBRT published the debit & credit card expenditure data for the week ended 28th October.

Insurance, petrol stations, markets, and restaurants stayed strong as past weeks indicate. It is notable that the electric & electronics expenditures got stronger, which is a bit unexpected given that the appetite for durable goods seems low at that stage. We should closely watch whether it is temporary or not.

Türk Traktör (TTRAK) Sales Data

Türk Traktör (TTRAK), the largest tractor producer in Turkey, announces its sale data monthly. Türk Traktör have 50 thousand tractor production capacity in a year. According to October sales data, the overall volume decreased by 2%. While export volume increased by 13%, domestic volume decreased by 10%. Therefore, if the volume is shrinking, the pricing will be very important.

We think that Türk Traktör can benefit from the current dynamics in Turkey. These are:

i)                 The future of agricultural production seems promising for farmers in the country. The main driver for farmers when deciding to produce more is what the sale prices level will be next year and the demand outlook. Right now, for farmers, we think that positive momentum is ahead.

ii)                The subsidy for domestic tractors will continue until the end of 2023. Under the scope of that program, the interest rate is 5.6% right now (do you know the CPI in Turkey?).

To conclude, in this inflationary environment, the attractive loan standards, and farmers’ appetite for more production can support tractor market. Farmers are likely to renew its old tractors in that environment. As company stated in its investor presentation, in Turkey, 48% of all tractors aged above 24 years. If not now, then, when?

Of course, there are risks. Our concern is that we do not know how much Türk Traktör capitalize these trends even if it is market leader. Because:

i) We do not know the price levels of all different companies. If Türk Traktör’s pricing is relatively expensive, maybe it can hinder the growth. Small companies can come to the fore. Even if farmers have positive outlook, they can prefer less expensive models to make saving due to the high level of uncertainty.

ii) The management of supply chain is critical. The supply of key materials (chips or something like that) can differentiate the performance of companies.

iii) As you realize, for now, the data does not confirm our predictions. The data should be closely watched.

Woven Fabric Export Data

Istanbul Textile and Raw Materials Exporters' Association (İTHİB) published woven fabric export data for October. The table below shows the total woolen woven fabric export of Turkey. Accordingly, Turkey’s woolen woven fabric export increased by 29% in dollar terms on an annual basis in October. This is a positive signal for YUNSA (even if it loses YoY growth momentum). The company makes a significant part of this export.

Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

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According to the results of the Türk-İş Survey in October 2022, food inflation increased by 2.48% monthly, and 134.77% annually, breaking a record. [Türk-İş surveys measure the food inflation in Ankara and the basket tries to track the food consumption of a family of 4. – GC] - Dünya

Turkey experienced a historic day yesterday, the 99th anniversary of the Republic. The campus in Gemlik, where the domestic car Togg will be produced, was opened and the first electric car was unloaded. Erdoğan announced that pre-orders for the Togg will begin in February. Regarding the price of the car, "The price of Togg will also be announced in February when the pre-sale will start." he said – Hürriyet

With the revision made to tourism revenues, a drastic downward revision will take place in Turkey's current account deficit. This will automatically lead to a narrowing of the net error omission item –  BloombergHT

According to the foreign trade data of the Turkish Statistical Institute for September, the foreign trade deficit increased by 268.1% compared to the same month of the previous year, from $2.6 billion to $9.6 billion. Exports increased by 9.2% to $22.6 billion in September, while imports increased by 38.1% to $32.2 billion [almost entirely due to the energy price shocks. – GC] – Dünya

According to TUIK data, the seasonally adjusted confidence index increased by 0.9% in the services sector, 3.0% in the retail trade sector, and 2.8% in the construction sector in October compared to the previous month – BloombergHT

Foreign tourist arrivals to Turkey increased by 55.8% in September – BloombergHT

Culture and Tourism Minister Ersoy: Our year-end target is 50 million tourists, and 44 billion dollars revenue [This is roughly on par with the 2019 numbers in terms of the number of tourists, and above in revenue – GC] – BloombergHT

Turkey's natural gas imports decreased by 7.62% in August compared to the same month of the previous year and became approximately 3 billion 852 million cubic meters. [Demand seems to have been subdued in September and October as well, according to the EXIST data. – GC] – Dünya

The decision of corporations to be tax-exempt in converting their foreign currency into TRY accounts will also be valid for their 9-month balance sheets – Dünya

The used car market shrank by 20% in September compared to the same period of 2021 – BloombergHT

Publishing the summary of the Monetary Policy Committee meeting on October 20, in which the policy rate was lowered by 150 basis points above expectations, the CBRT stated that the recently-widened gap between policy rate-credit rates narrowed with the contribution of announced macroprudential measures – BloombergHT

Regarding the presidential candidacy debates, CHP Deputy Chairman Veli Ağbaba said, "Our organization and our party's candidate is Kemal Kılıçdaroğlu, but we say at every opportunity that we respect the will of the 6-table." [CHP is the main opposition, and 6-table is the alliance of 6 parties that is expected to nominate a single candidate in the presidential election next year, and they have yet to do so. – GC] – Dünya

İbrahim Erden, President of the Turkish Wind Energy Association, said that they expect a new field supply for wind and solar energy, which can be completed within 2 years. He also noted that they are waiting for legislation in the field of energy storage in Turkey – Dünya

According to the data of the Turkish White Goods Manufacturers Association (TÜRKBESD), white goods exports in 6 main product groups in the 9 months of 2022 were in line with the same period of the previous year, while domestic sales decreased by 5% – Anadolu Agency

Turkey's crude steel production decreased by 19.4% annually in September to 2.7 million tons – BloombergHT

Erdemir (EREGL) announced its third-quarter financial results. Erdemir's profitability declined significantly in that quarter. The company's EBITDA per ton decreased from 413 USD/ton in 3Q2021 to 124 USD/ton in 3Q2022 (it was 329 USD/ton in the second quarter) - BloombergHT

Tofaş (TOASO) announced its third-quarter financial results. The company achieved a net profit of 2.06 billion TRY in the third quarter of 2022, above the market expectation of 1.83 billion TRY, with the support of deferred tax income – BloombergHT

TAV Airports (TAVHL) achieved a net profit of 1 billion 574 million TRY in the third quarter of 2022, exceeding market expectations – BloombergHT

Türk Traktör (TTRAK) achieved a net profit of 652.7 million TRY in the third quarter of 2022, above the market expectation of 550 million TRY. Thus, the 9-month net profit of the company increased by 94% annually – BloombergHT

Akbank (AKBNK) achieved a net profit of 17.07 billion TRY in the third quarter of 2022, above the market expectation of 16.7 billion TRY - BloombergHT

Akbank (AKBNK) secured a $404 million syndicated loan from international markets. It amounted to $225 million and €177.5 million ($179 million) with SOFR +%4.25 and EURIBOR +%4 respectively. The roll-over ratio became 60%. Last year, Akbank secured a $460 million and €206.8 million syndication loan with Libor +2.15% and Euribor +1.75% respectively - BloombergHT

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Source: Bloomberg, Galata Chronicles’ calculations. (Last Observation: October 27, 2022)

The problem for Turkey is, it determines its domestic oil product prices via indexation to two European contracts: Platts European Market Scan CIF MED Genoa/Lavera Gasoline and Diesel. So, the domestic gasoline and diesel prices skyrocketed in Turkey as well.

Source: Galata Chronicles’ calculations, EMRA, Bloomberg

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In this article, we will argue that the current conditions require severing that indexation relationship and insulating the Turkish economy from what are basically the results of European mistakes in its energy policy while making sure that some of the discounts Turkey gets in its Russian oil imports that currently accrue in their entirety to Turkish refineries and distributors are reflected in the pump price consumers pay and propose a two-step plan for doing so.

Why?

Normally we would be inclined to adhere to the dictum “the solution to higher prices is higher prices”. If an unusual price formation goes on for a while, the natural expectation would be that that period of sustained extraordinary profits would beget investments in that industry and that would drive the prices down. In this case, however, there are a few reasons why this reasoning will not work:

1.        Oil refining investments have remarkably high fixed costs and investment lead-times. This essentially means that if a price anomaly is not forecast to last beyond, say, 4-5 years, it would not be enough to entice people to build refineries because it would not be worth it. And the current crack spreads do not forecast the current anomaly to last that long. (We do realize futures contracts are not exactly forecasts, oil nerds, calm down. You get our broad point.)

Source: Bloomberg

2.      The current predicament is more or less entirely because of the Russia-Ukraine War, which is, by its very nature, unpredictable. So, any refinery investment, either in Turkey or in Europe, the epicenter of this issue, predicated on the possibility of a never-ending war, and never-coming-back-Russian-supply-for-Europe would be particularly ill-advised and would deserve a much higher required return given the risk. So, it would not be an extreme stretch to say that such investments, especially in Europe, won’t be made by the private sector. That leaves governments but we have a hard time believing that European governments will form state-owned enterprises to build refineries in a continent where the energy policy is so unrealistic or non-existent that the absolute necessity of nuclear energy is still very much overlooked and controversial. So, the structural problem seems to be here to stay.

3.      Another sensible counterargument would be that lower gasoline and diesel prices would encourage more consumption which would deepen oil dependency and slow down the energy transition. The part about oil dependency is likely correct. The problem is, there is still no viable mass-market alternative that would be strengthened by high oil prices right now in Turkey. Therefore, high diesel prices are a huge net negative, dynamically speaking. There will be alternatives in a couple of years, and that is another reason why refinery investments are not happening globally and locally, but it is not here yet. That’s why an intervention that will remain in place until then is in order.

Why now?

Because the European Union embargo on Russian crude oil is scheduled to start on December 5 and the embargo on Russian oil products will be implemented as of February 5, 2023. This will not only create a scramble for oil and products in Europe, but it will also increase, or at least sustain the diesel crack spreads. If that happens, President Biden might also ban oil product exports to Europe, to prevent a spillover into the US that would obliterate his re-election chances and strongly dent the support for Democrats, and that would pretty much cause European prices to skyrocket immediately. (Though that is admittedly the nuclear option and seems unlikely for now, some reports suggest that Biden previously considered that and was persuaded otherwise by some of his aides because it would quite certainly demolish the transatlantic relationship.)

Therefore, as a country that currently does and will continue to buy Russian crude oil and oil products, Turkey subjecting itself to such an ordeal willingly would be a significantly bad decision and would basically mean paying for Europe’s past sins.

(Geopolitics Interlude: One possible question is, wouldn’t the EU and the US react to Turkey continuing to buy Russian crude and products after the embargo, and the answer is a forceful “no”. The main aim of the price caps and the embargoes is to decrease the price of oil but to keep the flow intact. Otherwise, global oil prices would skyrocket, and the latest OPEC+ production cut made sure of that. In fact, by buying more Russian crude on the cheap, Turkey, India, China, and many others would be doing a favor to the US and the EU because it would mean more “elsewhere crude” available for them. And the ongoing discussions about the price cap involve a price level that is quite close to the current Urals prices anyway.)

What?

The current excessive domestic diesel price issue has two parts, and we’ll propose a solution in two steps. The first step will involve dealing with Russian oil-related pricing issues:

Turkish refineries (TUPRAS and STAR) benefit from the Urals discount, and Turkish distributors import Russian diesel relatively cheaply, but the entirety of said benefits accrue to the importers and none to the end-users of the products. Turkey currently satisfies roughly 35 percent of its crude oil needs from Russia and Russia’s share in Turkish diesel imports is around 45-50 percent. Roughly two-thirds of Turkish domestic diesel consumption comes from local refineries and the rest is from direct imports.

Source: EMRA, Eurostat, Galata Chronicles’ calculations

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Currently, Russian crude oil is traded with a roughly 20-25 dollar discount to Dated Brent, and there seems to be a similar discount for oil products as well. That’s why Turkey is able to spend significantly less than it would have if it did not receive Russian supply, and as we said, this benefit accrues to the importers in full right now. Our calculations indicate that if the Russian crude oil and product discounts were fully reflected in the final tax-free prices, that would result in a 22 percent, or 3.55 lira decrease in the current diesel prices.

Our proposal’s first step is to start with a 75 percent Platts European Market Scan CIF MED Genoa/Lavera + 25 percent Russian diesel indexation. The reason why we didn’t immediately start with a full cost-plus type indexation that would result in a roughly 40 percent weight for Russian oil is that doing so would:

1.      Remove the incentive of refineries and importer-distributors to buy Russian crude oil and products and Turkey needs to buy more, not less from them.

2.      Because of the upcoming EU embargo, it will be impossible to import Russian oil using EU tankers, and that will likely cause some significant fluctuations in freight prices.

The actual rate can be adjusted more accurately by the regulators who are naturally more knowledgeable about the ongoing costs involved in buying from Russia.

The reason why we propose a two-step process is that refineries have a significant amount of crack spread hedges for the next two quarters, and it would significantly hurt refineries to force them to unwind said hedges immediately. And with the first step, we would be leaving the crack spreads accruing to the refineries largely intact so that their hedges would not blow up, and only their crude oil hedges would be affected, but the likely result would be that they will profit from that because of the relatively recent decline in the Urals margins. From TUPRAS’ latest quarterly report:

“As of 30 June 2022, and 31 December 2021, commodity derivative transactions consist of average refinery crack margin fixing transactions and crude oil sale and purchase transactions. Average refinery crack margin fixing transactions have been executed for, gasoline stocks of 2,268 thousand barrels, jet fuel stocks of 1,301 thousand barrels, diesel stocks of 4,114 thousand barrels, and fuel oil stocks of 1,108 thousand barrels for the third quarter of 2022. And gasoline stocks of 1,253 thousand, jet fuel stocks of 724 thousand, diesel stocks of 2,680 thousand, and fuel oil stocks of 629 thousand for the fourth quarter of 2022 (31 December 2021: Gasoline stocks of 551 thousand barrels, jet fuel stocks of 214 thousand barrels, diesel stocks of 1,061 thousand barrels and fuel oil stocks of 214 thousand barrels for the first quarter of 2022).”

One key thing about this first step is that the public should not know about the existence of a second step or the counterparties in those hedges would fleece the Turkish hedgers. (Yes, we do realize the irony in that sentence, but we have to make our proposal heard in some way and we, unfortunately, don’t have the cell phone numbers of the regulators.)

The second step involves enforcing a constant crack spread. We think a valuable benchmark in this regard is the trajectory of the diesel crack spreads between 2015 and February 2020 because that period was the new elevated normal after the oil price crash in 2014-2015. The average diesel crack spread then was 22.43%. But the refinery input prices like natural gas etc. increased a lot in the case of Turkey as well, so to adjust for that we add 2 standard deviations on top of that average and arrive at 33.3%. (Once again, the exact numbers are up to the regulators who are privy to the exact cost dynamics of the refineries.) If this is done, there’ll be an additional 2.35 Lira decline in the tax-free diesel price, and with the gain provided by the first step, we think a cut of 4.5-5.0 Liras is possible in the tax-included price, which would pretty much erase the price differential between diesel and gasoline.

We think two additional elements are necessary to prevent any hiccups:

1.      Re-exports of diesel by the distributors are fine and should just be registered.

2.      Exports of the refineries should be capped at their current levels.

We would love to hear from oil market professionals as to why our proposal would not work so that we can revise our points and plug those holes. The key thing is, Turkey needs to be shielded from the impact of the explosion in European diesel prices that will likely be with us for some time, one way or another.

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General Info:

As a subsidiary of Dogan Holding since 2012, Galata Wind generates electricity using 100% renewable energy with its 3 wind power plants (WPP), and 2 solar power plants (SPP) and sells this electricity. In sum, the company has a 269 MW total installed capacity, and 234.9 MW of this belongs to WPPs and 34.1 MW to SPPs. While its WPPs are licensed, its SPPs are unlicensed (we will explain why this is important for our post). The company had its IPO on April 2021 with the ticker of GWIND.

From the company’s corporate presentation

In Turkey, renewable electricity generation is supported by some incentives under the name of YEKDEM (tariffs that guaranteed a fixed purchasing price). YEKDEM is the “Renewable Energy Resources Support Scheme” to incentivize renewable energy investments in Turkey. Mersin and Şah WPPs were removed from the scope of YEKDEM in 2020, and 2021 respectively. Mersin WPP and Şah WPP became operational in 2010, and 2011 respectively. Right now, these plants sell electricity based on market conditions, not at a fixed price. Taşpınar WPP and two SPPs sell electricity at a fixed price within the scope of YEKDEM.

Taşpınar WPP will be able to sell electricity at a price of $94/MWh in the first 5 years of YEKDEM because domestic equipment is used in its construction (then, will decrease to $73/MWh for another 5-year period). Taşpınar WPP became operational at full capacity at the end of March 2021. On the other hand, the fixed price for SPPs (Çorum & Erzurum) under YEKDEM is $133/MWh until 2027, and 2028 respectively.

From the company’s corporate presentation

Additionally, the company also operates in the field of rooftop solar projects, albeit it is a small share in total revenues. Moreover, the company sells carbon certificates on the voluntary carbon market that is granted due to the carbon emissions reduction coming from renewable energy generation.

Galata Wind is targeting to expand its total installed capacity to a total of 500-550 MW by 2025 year-end via capacity extension in its power plants, and new power plant acquisitions in Turkey and abroad. Its commitment is to invest in renewable energy plants only.

From the company’s corporate presentation

Electricity Generation and Revenue Estimate for 3rd Quarter:

In that section, we will try to estimate the company’s third-quarter results, which will be announced in the coming days, or weeks. For licensed power plants, we can follow the generation data (plant-specific data) almost simultaneously on the EPİAŞ website. Galata Wind’s WPPs are licensed, while SPPs are not licensed. Therefore, we can multiply the generation data with the sales prices (YEKDEM price or market clearing price) and reach our revenue estimate coming from wind power plants. Attention! YEKDEM price is fixed, and it is easy to calculate for the relevant power plants (with an average USDTRY exchange rate). But all power plants (outside of YEKDEM) don’t have to sell their electricity at the market clearing price. Therefore, this is just an estimate. When the level of divergence between the market clearing price and the price in their bilateral agreements increases, our estimate will be getting more blurry. Moreover, since April 2022, there are different maximum settlement prices applied to the power plants based on their resource cost structure (natural gas, imported coal, domestic coal, renewables, etc.). Therefore, we should take these dynamics into the consideration. For the backtesting, I will use the data from the third quarter of last year to now (to be honest, there is a huge divergence before that period, probably because of large volumes of bilateral agreements that were priced differently).

Let’s begin.

The table below shows the generation of Galata Wind’s wind power plants (MWh):

Total generation from WPPs increased by 35% quarterly (not that much meaningful because of seasonality) and decreased by 2% annually.

For Mersin and Şah WPPs, we should use the market clearing price. We use the maximum settlement price for the months after March 2022.

For Taşpınar WPP, we should use YEKDEM price. USDTRY indicates the average exchange rate during the period.

Then, we can calculate the total revenue estimate coming from the wind power plants. “Actual” column indicates the reported revenue from WPPs.

There are two SPPs that sell its electricity through fixed YEKDEM price ($133/MWh). Based on the historical data, in the third quarter, two SPPs are likely to generate around 16.000 MWh. With an average USDTRY exchange rate (17.93), their contribution to the revenue is likely to reach 38 million TRY. Therefore, our estimate for the revenue from WPPs and SPPs is around 339 million TRY. If we roughly calculate the contribution of carbon certificate sales and add other items, we can say that Galata Wind’s revenue will be somewhere around 340-350 million TRY. We can't wait to see the actual results.

Thanks for your attention.

Credit Card & Debit Card Expenditure Data

As a routine, we will publish credit card & debit card expenditure data:

Petrol stations and accommodation maintain a strong stance. Insurance and telecommunication are getting stronger gradually. On the other hand, it is notable that electronics go down drastically.

See you in the next post!

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Disclaimer:

The articles on this website are for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

The Central Bank of the Republic of Turkey (CBRT) lowered the policy rate by 150 basis points to 10.50%. The market expectation was to cut the interest rate by 100 basis points. The CBRT signaled in its decision text that a similar rate cut would be made in November and that the interest rate cycle would be completed – BloombergHT

Following the Central Bank's rate cut, the BRSA took a new macroprudential measure to tighten the loan market. For companies that can use loans, the FX position limit, which was 15 million TL before, was reduced to 10 million TL. The credit limit applied to companies whose "cash position exceeds 10%, whichever is greater than total assets or 1-year net sales revenue", has been updated to 5% – Dünya

According to the Housing Sale Market Outlook October 2022 note prepared by BETAM, the annual rate of increase in prices across the country decreased by 1.9 points compared to the previous month. Thus, this rate decreased for the first time after July 2021. According to the report, the annual rate of price increase in Istanbul in September decreased by 9.4 points compared to the previous month. Compared to the previous month, the number of ads for sale increased by 2.8%, while the number of houses sold decreased by 14.0% – BloombergHT

According to the housing price index of the Central Bank of the Republic of Turkey (CBRT) for August, prices increased by 185% compared to the same period of the previous year. Housing prices in Istanbul increased by 211% in the same period – BloombergHT

It was stated that Iranian Oil Minister Javad Owji came to Turkey for gas talks and met with Energy and Natural Resources Minister Fatih Dönmez, Treasury and Finance Minister Nureddin Nebati, and Central Bank Governor Şahap Kavcıoğlu. According to the news, the meeting discussed the renewal of the contract for the export of Iranian gas to Turkey, which will expire in 2026 [A significant number of the long-term natural gas contracts of Turkey are going to be expiring until 2026 – GC] – BloombergHT

Speaking about the reaction of the US to the decision of the OPEC and OPEC+ group to reduce daily oil production as of November, Foreign Minister Mevlüt Çavuşoğlu said, "If you want prices to fall, lift the embargoes on the countries that will offer products to the market." – BloombergHT

Presidential Spokesperson İbrahim Kalın stated that the negotiations regarding the postponement of the Russian gas payments of BOTAŞ to 2024 are continuing – BloombergHT

Aleksey Likhachev, General Director of the Russian State Atomic Energy Agency Rosatom, announced that they have started negotiations with Turkey on the construction of a nuclear power plant in Sinop [Sinop Nuclear Power Station was going to be built by a French-Japanese consortium, but the consortium left the project because of the rapid rise in the cost, according to them – GC] – NTV

The Ministry of Commerce announced that the regulation to monitor the number of mobile phones brought by passengers from abroad over a 3-year period and to prevent passengers from bringing more than one phone in 3 years beyond their exemption rights will be put into effect on 1 November [Turkey wants to discourage imported phone and especially iPhone usage, and Turkey has the highest USD price for iPhones on earth, but people purchasing iPhones abroad during their trips and bringing them back to Turkey for their own use or to sell them was an obstacle in that regard – GC] – Dünya

Speaking at the 'Blockchain Istanbul' summit held at Istanbul University, President Recep Tayyip Erdoğan said that a study on crypto money is being carried out within the body of the Central Bank. "We are trying to establish our own universe instead of trying to take place in virtual universes opened by others," said Erdogan. [President Erdogan is probably talking about the Central Bank Digital Currency project of the CBRT, which has been ongoing for a couple of years now and is expected to be finalized in the next year or two - GC] – BloombergHT

As of the week of October 14, foreign investors made net sales of 169 million dollars in stocks and 17 million dollars in bonds. With the latest data, the total portfolio outflows in 2022 were 5.8 billion dollars – NTV

Referring to the talks he had with Ukrainian President Zelenskiy and Russian President Vladimir Putin, President Recep Tayyip Erdoğan stated that there is no obstacle to the extension of the grain corridor agreement – BloombergHT

President Erdoğan said, "The normalization processes between Azerbaijan-Armenia and Turkey-Armenia are progressing in a way that supports each other, this opportunity should be used in the best way possible" - BloombergHT

The reserves of the Central Bank of the Republic of Turkey are at the highest level of the year with 116 billion dollars - NTV

According to the data announced by Turkstat, the Agricultural Input Price Index increased by 1.64% monthly, and 135.06% annually in August (a historically high annual increase). The sub-group with the highest annual increase was the fertilizer and soil improvers group with an increase of 234.48%. The subgroup with the highest monthly increase was the seed and planting material group with an increase of 9.62% - TRT Haber

According to the data announced by Turkstat, producer prices in agricultural products increased by 7% monthly, and 156% annually – NTV

Turkey's automotive production in September increased by 20.5% compared to the same month of the previous year and reached 128,872 units. In September last year, the production was 106 thousand 988 units - BloombergHT

Cengiz Eroldu, President of the Automotive Industry Association (OSD), stated that the automotive companies having facilities in the Far East production centers want to move to Turkey. Eroldu underlined the Italian companies specifically - BloombergHT

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