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Edited Transcript of KCHOL.IS earnings conference call or presentation 8-Nov-19 4:15pm GMT

Q3 2019 Koc Holding AS Earnings Call

Istanbul Nov 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Koc Holding AS earnings conference call or presentation Friday, November 8, 2019 at 4:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Nursel Ilgen

Koç Holding A.S. - IR Coordinator

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Conference Call Participants

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* Cenk Orcan

HSBC, Research Division - Co-Head of Turkey Equity Research, Director of Research and Analyst

* Hanzade Kilickiran

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. I am Gaye, your Chorus Call operator. Welcome, and thank you for joining the Koç Holding conference call to present and discuss the 9 months 2019 financial results. (Operator Instructions) The conference is being recorded. The presentation will be followed by a question-and-answer session.

(Operator Instructions) At this time, I would like to turn the conference over to Ms. Nursel Ilgen, Investor Relations Coordinator at Koç Holdings. Ms. Ilgen, you may now proceed.

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [2]

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Thank you, [Gaye Lee]. Welcome all, and thank you for joining us. This is Nursel, IR Coordinator of Koç Holdings. I have here with me our finance coordinator, Fatih Sertdemir.

Just before we start, I would like to remind you that our presentation and the Q&A session may contain forward-looking statements. Our assumptions are based on the environment in our businesses as we see them today, and this might be subject to change.

Before the call, we had sent out our e-bulletin, which contains a link to our earnings presentation. After the call, you can also access a replay facility on our left side, together with the transcript, as always.

Now I would like to start with the presentation, and you'll have a Q&A session at the end. Let's start on Slide 2.

I would like to start by giving you a quick overview of our positioning. We were able to manage volatility and proved our resilience one more time, mainly thanks to our diversified portfolio structure and our disciplined risk policies. In this period, we have sustained dividend income to a large extent, despite the volatile environment. Another factor which contributes to the sustainable [Tier 5] dividend slope is the fact that 80% of our dividend income is derived from companies that have FX or FX linked revenues. This year's dividend income of TRY 2.5 billion, includes for total (inaudible) announced second dividend payment of TRY 166 million, which will be reflected in the fourth quarter.

Therefore, the main components that ensure the sustainability are: We have a structurally diversified portfolio, which hedges us against sector-specific sensitivities and cyclicalities. No single sector represents more than 30% of our NAV. We are the largest exporting group in Turkey, with our exports accounting for 10% of Turkey's total exports. In terms of the composition of our own revenues on a combined basis, total 3% is coming from international sales as of first 9 months of 2019. If we also include Tüpras, which is a FX linked commodity business, 55% of our revenues can be considered not sensitive to the domestic market.

We have leading positions in the sectors that we operate. This allows us to maintain our strong pricing power. In this regard, we manage our balance sheet and investments to ensure that we always remain resilient.

On Slide 3, you can see the main pillars of our solid balance sheet. As you all know, prudent management has always been a key focus area. As the largest company in Turkey, active in many diversified sectors, we manage our balance sheet to ensure that we always remain resilient against market volatility. At the holding stand-alone level, we like to keep a certain level of cash to serve as a war chest against volatility as well as buying power should investment opportunities arise. As of the end of September 2019, our net cash position at the holding level stood at $427 million. As you know, in January 2019, we participated in Yapi Kredi Bank's AT1 issuance with $200 million. Therefore, including the Yapi Kredi Bank AT1 investment, with a group interest, our net cash reached $651 million. Our gross cash is close to $2.7 billion and 78% of this position is kept in hard currency. In terms of our funding at Koç Holdings level, we have 3 Eurobonds, including our latest Eurobond issuance of $750 million in March of this year. The issue was a 6-year notes, priced with a coupon of 6.5%. The issuance allow Koç Holding to prefund the Eurobonds, totaling against $750 million during April 2020, 1 year in advance.

The funds are mainly being kept in short-term dollar time deposits. We have no other debt at Koç Holding standalone level. As a reminder, Koç Holding's ratings are BB- on S&P, 1 notch above Turkey's sovereign rating, and C1 from Moody's, flat to Turkey's sovereign.

We also have well-defined and prudent risk management policies that are regularly monitored full on a combined basis and at each underlying company. In terms of liquidity, leverage and foreign exchange position, we are at conservative levels. On a combined basis, our current ratio is 1.4x, and our net financial debt-to-EBITDA is 1.7x. Note that these figures exclude IFRS 16 effect, but at Koç Holding combined level, the effect of IFRS 16 are negligible on net financial debt-to-EBITDA ratio. In terms of FX, we have a policy of keeping a neutral position, and we remain well within our risk management rules. As of September, we are slightly long dollars, both on solo and consolidated basis.

Now I would like to briefly summarize our first 9 months performance, focusing on our main segments. Let's start with Energy and Tüpras on Slide 4. The domestic demand for refined products continued its downward trend in the first 8 months of 2019. We saw 5% decrease in diesel sales volume compared to the same period last year.

On the other hand, jet fuel and gasoline were resilient and posted 3% and 1% growth, respectively.

Tüpras' domestic sales volume was down by 13% in the first 9 months of 2019, while exports volume almost doubled, leading to flattish total sales volume. Now we look at the refining margins, we see $1.60 per barrel decline in the Med Complex margin to $2.90 per barrel due to lower gasoline effect in the first half and high sulphur fuel at crack margins in the third quarter.

Tight world gas differentials was another factor that compressed net margin in the first 9 months of this year. On the other hand, Tüpras net refining margin was $0.8 higher than Med Complex margin, mainly thanks to the higher wide product yield and better crude selection ability of the company. Tüpras' overall net refining margin amounted $3.7 per barrel versus $10.7 per barrel during the same period of last year, mainly due to narrow differentials, Residuum Upgrade Project maintenance impact and [environmental] impact.

In terms of capacity utilization, Tüpras operated mix 98% capacity utilization rate despite the RUP maintenance, which started on February 26 and completed on May 13, nearly 2 weeks ahead of schedule. Although this maintenance had a negative impact of around $100 million in the first half on EBITDA, with the completion, Tüpras is fully positioned to take its advantage of the upcoming IMO 2020 regulation change.

Based on 9-month development, year-end expectations have been revised for Tüpras. Accordingly, Med Complex margin expectations lowered from $3.75 to $4.25 per barrel to $2.75 to $3.25 per barrel, while Tüpras net refining margins is reduced $4 to $4.5 per barrel from $6 to $7 per barrel. Tüpras also reduced refining related CapEx guidance from $200 million to $150 million in 2019.

Capacity utilizations maintained at around 95% to 100%. On the LPG side, consumption decreased by 1% in the first 8 months of 2019. Aygaz, the leading player in the LPG sector, focused on profitability, and its sales volume was flattish thanks to its exports. For 2019, Aygaz expects 2% to 3% contraction in sector volumes, while, for itself, market share is expected to remain flattish. Accordingly, looking at the Energy segment contribution to Koç Holding, we can see that it is shown in combined operating profit and consolidated net income are 28% and 7%, respectively. Net income contribution was impacted mainly due to tightened crude oil differentials, lower inventory yield as well as higher natural gas price and a negative impact of plant maintenance.

Let's move on Slide 5 and discuss the developments in the Auto segment. After a 25% contraction in 2018 for the whole year, the first 9 months of this year witnessed 40% year-on-year decline in market volume, with recovering since September.

In this period, our auto companies focused on profitability of domestic market and managed to take advantage of some government incentives, especially Tofas, with its Egea passenger car. Accordingly, our market share in the domestic market increased by 3 percentage points to 25%. On the export side, our group market share remains solid, especially supported by the strong performance of Ford Otosan. During this period, Ford Otosan increased its export volume by 4% year-over-year, thanks to ongoing growth in the European commercial vehicle market, with Ford Europe's sustained leadership.

Tofas, on the other hand, witnessed 22% decline in its export volumes, while Tüpras management's full year guidance implies approximately 16% year-on-year decline. As you all know, more volumes than actual sales are guaranteed on the take-or-pay contracts. Therefore, impact of the declining export volume on Tüpras' profitability is limited. Looking at the total revenue performance of Ford Otosan and Tüpras, we can see 19% growth and 2% decline, respectively.

International revenues were the main driver for both companies, supported by euro-based cost-plus contracts, and in the case of Tüpras, also take-or-pay. These contracts allow our auto companies to remain resilient in periods of TL depreciation and domestic market slowdown. For both companies, international revenues contributed around 80% to 85% to their total revenues.

Regarding 2019 expectation, both companies made some revisions. We expect around 25% contraction in the domestic market, pointed to 450,000 to 500,000 units for total auto sales, which is the guidance of Ford Otosan, and 470,000 to 490,000 units for light vehicle, which is the guidance of Tüpras. Ford Otosan expects its real sales volume to be around 40,000 to 50,000 units with 35% decline, while Tüpras increases expectations to 72,000 to 75,000 units, almost flat compared to 2018 figure, mainly thanks to the market share gains in the passenger car segment.

Regarding the exports, Ford Otosan expects volume to hover around 335,000 to 345,000 units, while approximately 3% -- with approximately 3% year-on-year growth, indicating a historical high figure. Tofas, on the other hand, expect around 16% volume contraction to 200,000 to 210,000 units, but the P&L impact will be limited as we've mentioned earlier, thanks to take-or-pay contracts, which are in excess of this figure.

All in all, recovering domestic sales on the back of cheap loan campaigns by State Bank in collaboration with domestic producers that will remain in effect between October to end of the year, as well as solid export contracts and cost discipline will ensure resilience for our auto companies in the last quarter of the year.

Let's also touch upon our tractor company, TürkTraktör. In the first 9 months, the farmers' [spend] has deteriorated and demand was severely impacted by higher input costs. During this time, TürkTraktör domestic sales volume declined by 54% year-on-year despite the recovery since August. This was partly offset by strong export sales with 15% volume increase. Accordingly, TürkTraktör revenues declined by 9%, mainly supported by price increases and currency impacts. For 2019, TürkTraktör decreased domestic sales guidance, still indicating a strong final quarter thanks to the decline in interest rates.

Otokar, our leading bus and defense company, had a very successful start to the year, thanks to its bus exports to Bucharest and Amman municipalities as well as armored vehicle exports. These orders have been the result of superior R&D capabilities and successful products of Otokar. In this period, export revenue surged more than 4x to over TRY 1.5 billion, constituting 82% of total revenues.

Accordingly, total revenues more than doubled in the first 9 months. Overall, compared to a net loss figure a year ago, Otokar reports close to TRY 300 million of net profit in the first 9 months.

In summary, we see solid performance from the Auto segment of Koç Holding. The Auto segment accounts for 30% of our combined operating profit and 37% of our consolidated net income. The Auto segment's operating profit increased by 10% despite a sharp decline in the domestic market. The main drivers of this positive performance were solid international revenues and export contracts as well as cost discipline. Accordingly, our Auto segment's consolidated net income increased 3%. Excluding the one-off link to the purchase gain on acquisition of car rental business in Greece by Otokoç in 2018, the Auto segment realized a 14% year-on-year growth in consolidated net income.

On Slide 6, we can look at the Consumer Durables segment. In the first 9 months of 2019, white goods sales in Turkey decreased by 10% year-over-year due to weak private consumption. On the other hand, special consumption tax cuts between November 2018 and June 2019 had a positive impact on the market. In international markets, Western Europe and Eastern Europe recovered slight increases of 2% and 3%, respectively.

White goods exports in the sector was up by 1% year-on-year. Looking at Arçelik figures, domestic revenues increased by 20%, thanks to outperformance of the market with a 6% increase in unit sales. Arçelik realized significant market share gains in this period. On the international sales front, which constituted 67% of our total, revenue growth was similar at 22% growth, mainly due to FX impacts as well as some organic growth and acquisition of Singer Bangladesh. In this period, Arçelik managed to increase its price index, especially in Western Europe. In terms of profitability, strong sales performance and stable raw material prices were among the positives of the first 9 months. Looking at the key metrics, Arçelik managed to maintain them at sustainable levels. The company's working capital-to-sales ratio was almost flat at 28.3% on strong performance of it in terms of receivables. Leverage also stayed at comfortable levels with a net debt-to-EBITDA ratio of 2.4x.

As a reminder, 17% of the existing debt will be rolled in the fourth quarter this year, with lower interest rates.

Regarding 2019 expectations, Arçelik confirmed its guidance. The domestic market is foreseen to decline by 15% year-on-year, in line with the Turkish white goods manufacturers and translation estimates, mainly due to the termination of the special consumption tax cuts at the end of June 2019.

Revenue growth is expected to be around 20% to 25%, supported by both domestic and international markets and consolidation of Bangladesh operations. EBITDA margin expectation is 10.5%, while risk metrics will be kept at sustainable levels.

Overall, the Consumer Durables segment operating profit increased by 22% year-on-year and contributed 13% of the group's combined operating profit. This performance was mainly driven by international revenues with pricing focus, supportive raw material prices and domestic volume growth despite contracting markets.

Finally, let me also briefly talk about the Finance segment and the development of Yapi Kredi on Slide 7.

Yapi Kredi's net income decreased by 7% year-on-year and amounted to TRY 3.3 billion, while pre-provision profit posted 9% year-on-year growth. Return on tangible equity was realized at 11.8%, and the bank applied a conservative approach in terms of cost of risk.

Cost growth was below the employee's inflation at 13%, thanks to cost discipline, while [balance] growth stood at 16% year-on-year on double-digit growth in both fees and net interest income. Accordingly, cost-to-income ratio slightly increased by 0.8 percentage points to 36.5%. In 9 months 2019, total loan growth was 1% year-to-date, while TL loan growth stood at 7%, supported by TRY 10.2 billion credit guarantee funds utilization. Customer deposit growth was 7% year-to-date, where the bank gained market share in value-added segments such as TL small ticket and demand deposits.

In line with the banking sector trends, NPL ratio increased to 6.7%. Total coverage ratio stood conservatively at 6.5%, which remains highest among peers. In terms of capital, the bank undertook several important initiatives in the last 1 year: a capital increase of TRY 4.1 billion in June 2018; and AT1 issuance of $650 million in June 2019; and sub-debt insurance executed in July 2019.

Following all these transactions, together with internal capital generation, capital adequacy ratio and Tier 1 ratio stood at 16.7% and 13.6% by September end, respectively, comfortably above the minimum requirements with a buffer of more than 400 basis points.

Yapi Kredi has confirmed its full year guidance. Accordingly, in 2019, the bank expect around 15% TL loan growth and mid-teens deposit growth. In terms of profitability, the bank expects return on tangible equity at low teens, incorporating flattish NIM margin, solid fee growth, below-average inflation cost growth and cost of risk below 300 basis points with continuation of its prudent risk appetite.

Overall, the Finance segment operating profit and consolidated net income declined slightly. Finance segment contributed to 29% of our combined operating profit. In terms of the share and consolidated net income, it has one of the highest contribution among our sectors with 37%.

If we move to the Slide 8, we can talk about the overall results of the group, incorporating all of the segments as we just discussed. On a combined basis, Koç Group registered TRY 243 billion in revenues, TRY 14.4 billion in operating profit and TRY 8.3 billion in net income. Consolidated net income amounted to TRY 3.3 billion, with 40% year-on-year decrease. Excluding the one-off gain of Otokoç in 2018, the decline in our consolidated net income would be 12%.

On Slide 9, we can see the breakdown of the consolidated net income performance. The biggest contributors were Finance and Auto segment, followed by Consumer Durables and Energy segment.

I would like to wrap up our presentation on Slide 10. In summary, we maintained our disciplined management approach, as always. Our balance sheet is strong with a solid cash position, and our portfolio structure and diversification ensure resilience against volatility. Value creation is always a key priority for us. And we are very well prepared with our solid and diverse businesses and tight risk control. Furthermore, given our strong cash position, we are also in a position to benefit from growth opportunities as they may arise.

So this concludes my presentation. Thank you for listening. Now we can open the floor for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from the line of Orcan Cenk with HSBC.

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Cenk Orcan, HSBC, Research Division - Co-Head of Turkey Equity Research, Director of Research and Analyst [2]

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Can you comment on how you see dividends next year, please? It looks like your collections may weaken considerably next year since energy profits are down 70% so far this year. Is that a fair assumption? Are there any compensating areas, you think, any possibility for the picture to improve, perhaps, in the fourth quarter?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [3]

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Cenk, thank you for the question. Well, as you know, none of the underlying companies provide any guidance about net profit or dividends. So net profit depends on many factors, including the year-end exchange rate levels, the revaluation rate and et cetera. So it is very hard for us to provide a guidance right now, from today, before regarding the dividend, regarding 2000 -- the dividends to be paid out of 2019 profit. So we will be working on the budget together with our companies, and the budget process will be towards end of the year. So the underlying companies will be able to provide guidance, most probably at the beginning of the year, when they announce, maybe, the year-end results. So currently, there's not a significant amount that we can say about this topic. But just remember that the dividend policies of our underlying companies, we always ask our underlying companies to pay the highest dividend as possible. So we decide on a dividend payments from our companies taking into account their balance sheet strength, their investment plan. And -- but the general policy is that our companies pay dividends unless they need it for growth, for capital purposes and the strength of their balance sheet. So the most important thing for us is the solidity and the sustainability of the underlying company. So we do not force our companies to pay dividends, but we also don't like them to be sitting with excess cash while maintaining a full balance sheet. Therefore, the decisions will be made looking all these perspectives during the budget process.

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Operator [4]

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The next question is from the line of Kilickiran Hanzade with JPMorgan.

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Hanzade Kilickiran, JP Morgan Chase & Co, Research Division - Analyst [5]

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I have question on the guidance. Can you please wrap up your company's guidances -- guidance changes after the Q3 numbers?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [6]

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Sure.

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Hanzade Kilickiran, JP Morgan Chase & Co, Research Division - Analyst [7]

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So which company increased -- I mean cut the guidance, or which company and sector raised the guidances?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [8]

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Sure. We have -- thank you. Thanks for the question, Hanzade. The auto companies revised their guidance for Turkey -- for the Turkish auto market upwards. So for Ford Otosan as an example, they were expecting the Turkish auto market to be around 380,000 to 430,000 units. Now, they announced that they revised their guidance upwards to 450,000 to 500,000 units. So that implies around 25% year-on-year decline. And previously, the decline expectation was close to 26%. And Tofas, similarly, they revised their guidance from 380,000 to 400,000; to 470,000 to 490,000 units for the light vehicles. So that's only for the light vehicle market, and that implies a decline of close to 23%, taking the midpoint of the guidance. And previously, that was something like 27%. So they revised their guidance for Turkish market upwards, mainly because of the recent trends, mainly because of the recent decline in the interest rates. And would you like me to go over the retail sales of export guidance because there I see some...

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Hanzade Kilickiran, JP Morgan Chase & Co, Research Division - Analyst [9]

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No. No. No, I just -- I really -- I wonder on a broad perspective, which sectors have guidance upgrade and which sectors have guidance downgrade?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [10]

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Okay, okay. So the auto companies revised their guidance upwards regarding the Turkish market, except for TürkTraktör, they revised their guidance downwards. They were expecting a higher Turkish market before. So -- but still, we see some recurring in the tractor market since August this year. So they are currently expecting something like 45% decrease and previously that was, again, something like -- that is much, much, much -- let's say, much less figure. So I don't have the exact number in front of me. But they are expecting a contraction. Within -- let's say, with some recovery in these sales -- domestic sales units in the final quarter of the year. Yapi Kredi maintained the guidance and Aygaz and also -- which company -- and Arçelik, they also maintained their guidance. So Tüpras revised its guidance downwards, yesterday. That's mainly because of the Med Complex margin expectation. So they decreased both Med Complex margins and also the net margin expectation, in line with the recent trends and in line with 9 months development. By the way, Tüpras revised its guidance regarding the CapEx downwards from $200 million to $150 million. And similarly, TürkTraktör also revised its CapEx guidance downwards to 150 -- something like $150 million. So it's a range of $140 million to $160 million. And there was no change for Tofas. And Ford Otosan, again, they maintained their CapEx guidance as it is.

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Hanzade Kilickiran, JP Morgan Chase & Co, Research Division - Analyst [11]

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And can I also ask one more question about Yapi Kredi. We received lots of questions about your interest in the Yapi Kredi, your strategy in the Yapi Kredi in the event of an exit by UniCredit. What do you think about your stake in Yapi Kredi at the moment?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [12]

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Yes. Okay. Of course, there have been some news in the media about this. First, we already made an announcement officially saying that the we evaluate the shareholder sectors of our portfolio companies. We may engage in discussions with relevant parties at all times. In the case that concrete decision is reached, necessary disclosures are made. So that is our official statement. And secondly, as Koç Holding, we have always -- we see the finance is one of our core sectors, strategically. So we do believe in the long-term potential of the banking sector and also in Yapi Kredi. So based on detailed long-term analysis that we have done, we believe that the banking offers attractive growth and profitability going forward. And Yapi Kredi has a very clear strategic plan, and we are fully confident that they will achieve which is target. The refreshed management team, they have -- with a new vision, they will be -- we believe in the refreshed management team, I mean to say. So we support the bank, and we think that they will be able to create sustainable shareholder return. And we have full commitment to the bank, as evidenced by the rights issue in June 2018, and also the AT1 issuance in January this year. So we are committed to supporting the bank in any form going forward. That's all I can say.

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Operator [13]

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(Operator Instructions) We have a follow-up question from Mr. Orcan Cenk with HSBC.

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Cenk Orcan, HSBC, Research Division - Co-Head of Turkey Equity Research, Director of Research and Analyst [14]

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Nursel, any feel how the NA market is shaping up in Turkey? Is it good times to buy distressed assets? Are there any areas that you are looking into? How do you view year 2020 in that respect?

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [15]

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Well, in terms of investments, yes, as an investment holding company, as Koç Holding, we always scan the marketplace, both domestically and internationally. And our job is to deploy our capital in growth areas with returns that are acceptable to us. That means that we are seeking for returns in excess of the cost of capital that we are calculating based on a risk-adjusted basis. So having said that, we are currently quite content in the sectors that we are operating. But of course, looking forward, growing these sectors, depending on the sector locally or internationally, as I said, we are continuing to scan the marketplace. So we may expand in our existing sectors or adjacent sectors. So you know that we have a company in the energy business, Entek. And currently, the company is -- they have hydropower plants and some natural gas-fired power plants. So the Entek is focused on ensuring resource diversification and also in production. And the company prioritizes renewable energy investments, including, but not limited, of course, to wind and solar power plants. So we don't have any target in terms of capacity, or in terms of, let's say, a numerical target. But the aim to grow the business selectively. So currently, yes, I can say that there may be some opportunities, but as always, we are being recollective.

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Operator [16]

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(Operator Instructions) Ladies and gentlemen, there are no further questions at this time. I will now turn the conference over to management for any closing comments. Thank you.

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Nursel Ilgen, Koç Holding A.S. - IR Coordinator [17]

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Thank you. So before closing, I would like to extend our appreciation one more time to all participants. And if you have any further questions, you can always get back to us by phone or by e-mail. As a reminder, our presentation and a replay of this conference call can be found on our website together with the transcript. We hope to see you again in our next webcast, when we will be announcing our full year performance for 2019, if not sooner. Bye-bye.

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Operator [18]

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Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for calling and have a pleasant evening.