Our ratings on Turkish companies took a turn for the better at the end of last year, with a wave of positive rating actions. This followed our revision of the outlook on Türkiye to positive in November 2023, ending the gradual downward trajectory of the long-term sovereign credit rating to 'B' in 2022 from 'BB' in 2018.

Turkish companies have had a lot to contend with in recent years, with high inflation, a volatile currency, and high interest rates. Nevertheless, most companies that we rate have managed to preserve their stand-alone creditworthiness, and are in a good position to benefit from the recent shift toward a more orthodox economic policy.

S&P Global Ratings believes that Turkish companies will maintain their current leverage and interest coverage metrics despite rising interest rates. Moreover, we do not envisage any further deterioration in profitability because of high inflation. We believe that if the policy reforms continue as planned, Turkish companies might benefit from better access to international capital markets. This will allow them to gradually increase investments and return to growth, rather than just focusing on surviving.

Risks still abound, with the key ones being a hard landing in Türkiye, an economic slowdown in the eurozone, volatile exchange rates, and uncertainty over the sustainability of the government's policy shift.

Rated Turkish Companies Maintain Solid Stand-Alone Creditworthiness Despite Headwinds

Ratings in the 'B' category are the most common in our portfolio of rated Turkish companies because of the sovereign rating constraints (see chart 1). That said, we rate more than half of the companies above that level, as we believe they can withstand a hypothetical sovereign default.

Most rated companies have managed to preserve their stand-alone creditworthiness at even higher levels, with an even distribution among the 'b', 'bb', and 'bbb' categories (see chart 2). This indicates the potential for long-term rating upside now that the sovereign rating trajectory has turned positive following the recent policy shift.

We have not seen any defaults among rated Turkish companies since 2020, and there have been virtually no conventional defaults among unrated listed Turkish companies over this period. This is true even if we recognize cases of forbearance and debt restructuring among some unrated companies, as is evident from the increased share of stage 2 loans on the balance sheets of large Turkish banks, based on their public disclosures. (Stage 2 loans are loans that show a significant deterioration in credit quality since origination, but no objective evidence of a credit loss event.)

Chart 1

Chart 2

Turkish Companies' Leverage Should Remain Moderate, Comparing Well With The Emerging-Market Average

We forecast that rated Turkish companies will be able to broadly maintain their leverage in 2024-2025, despite our expectation that the macroeconomic environment will remain challenging.

The average debt to EBITDA of rated Turkish companies is already lower than that of their Brazilian, South African, or Indian peers, as well as the emerging-market average (see chart 3). It is quite common for companies operating in countries that are experiencing macroeconomic stress, including high inflation, to demonstrate prudent financial management. Cutting long-term investments, prioritizing projects with predictable cash generation, and limiting shareholder remuneration have allowed Turkish companies to avoid sizable debt increases and offset reduced profits.

Chart 3

Our base-case scenario is for Turkish companies' capital expenditure to increase in 2024-2025 (see chart 4), as they gain confidence in the domestic economy and continue to service the export markets, and especially if they manage to raise debt in the international capital markets. This could help them switch from navigating turbulent waters to focusing on growth opportunities while preserving their balance sheets.

Chart 4

Economic Weakness And Exchange-Rate Volatility Are Among The Top Risks For Turkish Companies

High interest rates and geopolitical turbulence are key risks for all emerging-market companies. In addition, the Turkish economy remains highly sensitive to energy price movements, which could see only a slight improvement with the launch of the Akkuyu nuclear power plant in 2024 and more renewable projects coming on stream. Uncertainty over the sustainability of the Turkish government's policy shift is another major risk for the Turkish economy. The other risks specific to Turkish companies in 2024-2025 include:

A hard landing for the Turkish economy

We project GDP growth of 2.4% for Türkiye in 2024, less than half of the 2021-2022 average. Nevertheless, we cannot rule out the possibility of a hard landing, that is, a full-year contraction. This is because, on the one hand, the pace of private consumption growth in 2022 and 2023 was unusually high, at 16.3% and 12.0%, respectively, drawing in imports and leading to an unsustainable current account deficit of just under 6% of annualized GDP in October 2023. By September 2023, however, there were already signs of cooling demand, as imports started to decline, and Türkiye posted two consecutive months of current account surpluses.

Moreover, given our expectation of a further 30% devaluation of the Turkish lira in 2024, Turkish companies, which are highly exposed to the domestic markets and net importers of goods, might not be able to fully pass through the costs to end customers. With consumers less willing to borrow to support consumption as domestic rates increase, companies selling nonessential goods or services might be particularly vulnerable. At the same time, fiscal policy (including earthquake spending) is likely to shore up demand ahead of early local elections at the end of March this year. In addition, key sectors, especially tourism, have proven highly resilient to a series of external and internal shocks.

An even more pronounced economic slowdown in the eurozone, the main market for Türkiye's largest exporters

We expect real GDP in Germany, Türkiye's main trading partner, to improve modestly to 0.5% in 2024 (versus our expectation of a 0.2% contraction in 2023), as consumption recovers slowly. A weak European economy is still our baseline expectation, and this will impinge on Türkiye's export sector for yet another year in 2024.

The volatility of multiple exchange rates

Generally speaking, devaluation of the local currency benefits exporters and improves their global competitiveness. At the same time, it poses multiple risks for working capital management and investments. Moreover, many rated Turkish companies are exposed through their purchases to other currencies on top of the euro, including the U.S. dollar and Chinese yuan. This creates additional exposure that has already resulted in a few companies seeing their profits deteriorate on multiple occasions in the past.

Inflationary Pressures Should Ease In 2024-2025, But From A High Level

We forecast that inflation will remain high in Türkiye, at close to 50% in 2024 and close to 30% in 2025, but this should not significantly affect the performance of Turkish companies. We believe that the main hit to their profitability happened in 2022-2023, when we saw margins declining in consumer-driven sectors. Surprisingly, the margins of some consumer goods companies had already started to recover in 2023, but many companies were unable to fully pass through costs to their end customers in the unstable inflationary environment.

Inflationary risks will remain elevated in 2024, as households' propensity to spend comes up against the rising cost of consumer credit and the likely depreciation of the Turkish lira. Looking ahead to 2025, more predictable inflation and exchange rates could boost consumer confidence and pricing power.

Overall, we still believe that rated Turkish companies' profitability will largely remain unchanged on average in 2024, with some potential for improvement from 2025 if, as we expect, the shift to a more predictable economic policy brings inflation down (see chart 5).

Chart 5

Rated Turkish Players Generally Have Adequate Liquidity

More than three-quarters of rated Turkish companies maintain adequate liquidity, with no cases of weak liquidity (see chart 6). Notably, this distribution is not wholly representative of the situation in the unrated corporate universe.

Liquidity has been an important consideration in the credit profiles of many Turkish companies for years. Excessive reliance on the rollover of short-term debt from domestic banks has long been a distinctive feature of the liquidity of many small and midsize Turkish companies, and has constrained the ratings at low levels. Some companies, like Vestel, have defaulted because of liquidity issues. Only for large blue-chip companies with relatively low leverage, such as Coca-Cola Icecek AS or Turkcell Iletisim Hizmetleri A.S., has liquidity never been an issue.

Chart 6

Committed credit lines are still virtually nonexistent in Türkiye. This prevents companies from achieving decent liquidity unless they attract long-term financing from international capital markets or sit on large cash piles. As international capital markets are becoming increasingly accessible, we expect more second-tier Turkish companies to start issuing Eurobonds or raising long-term credit lines from international banks. Refinancing a sizable portion of short-term domestic bank debt with longer-term debt should strengthen Turkish companies' liquidity. That said, we believe that investors will only be willing to take the long-term risk if they believe in the stability of the Turkish government's policies and the improvement in macroeconomic conditions.

The bond capital market was virtually closed for Turkish companies between 2021 and mid-2023, as they repaid rather than refinanced their maturing Eurobonds. The situation is now changing, and Turkish banks and companies have recently started to issue Eurobonds, supported by the compression in U.S. interest rates and a softer U.S. dollar.

In the past few months, Arcelik A.S., Mersin International Port, and TAV Airports have all issued Eurobonds, solidifying their liquidity positions. As many emerging markets face their own challenges and some large emerging markets like Russia are completely out of the picture, emerging-market investors are generally interested in taking a risk on healthy Turkish companies, especially exporters. We also believe that investors appreciate Turkish companies' strength relative to other emerging markets in terms of their reporting and environmental, social, and corporate governance.

We Don't Expect Rated Turkish Companies' Interest Coverage Metrics To Deteriorate Further

High interest rates pose a risk to all emerging-market companies. We expect the effect to be steady, gradually increasing interest costs for rated companies in these markets. Growing interest costs could force the companies to reduce their investments to support healthy debt service in the most exposed regions.

However, in our view, Turkish companies' exposure to high interest rates differs slightly from that of other emerging-market players. Their starting point is different, as interest rates on domestic loans and bonds have been high for a number of years in Türkiye. Interest coverage ratios, such as EBITDA to interest, have been gradually deteriorating on average since 2020, unlike in other emerging markets, where the trend is more recent.

We believe that two important trends will emerge in the next 12 months. We expect domestic rates in Türkiye to continue increasing in 2024, in line with the central bank's policy. But as this is fairly predictable, we believe it represents less of a risk to companies. At the same time, the reopening of international capital markets should allow Turkish companies to extend their debt maturity profiles and establish a longer-term time horizon for investments, capital allocation, and liquidity management. This might be particularly credit positive for exporters, as it would allow them to better match their cash flow currencies without creating additional foreign-exchange risk. It might also help them reduce their interest costs, as bonds yields, despite being higher than in the past, are well below what the domestic banks could offer. Companies will need to play it wisely, though, to avoid locking in these higher rates for long.

In light of this, and because we expect most rated Turkish companies to maintain broadly flat leverage, we don't foresee any further deterioration in their interest coverage ratios in 2024-2025 (see chart 7). Moreover, depending on the exchange rates and the ease of issuing Eurobonds, the ratios could start improving, notably for exporters. That said, the situation might be different for smaller, more domestically focused, unrated companies that do not have access to the international capital markets.

Chart 7

Arcelik is one of the companies with weak interest coverage ratios for the rating, as it largely relies on expensive domestic financing. As such, the effective interest rate on its local-currency short-term debt was 33% in September 2023. Arcelik recently issued a $400 million Eurobond with a coupon rate of 8.5%. This should help improve its liquidity and contain the increase in its interest cost depending on foreign-exchange valuations.

We Rate An Increasing Number Of Turkish Companies Above The Sovereign

We recently raised our transfer and convertibility (T&C) assessment on Türkiye to 'B+' from 'B', despite the sovereign rating remaining at 'B'. In many instances, neither the sovereign rating nor the T&C caps the ratings on Turkish companies. Exporters or, more broadly, companies that generate a meaningful amount of revenue in hard currency, and companies with ample liquidity buffers are still the prime candidates to exceed the sovereign rating or T&C cap.

Another way to offset sovereign rating constraints is to have cash-generating operations outside the country. Some Turkish companies, like Anadolu Efes Biracilik ve Malt Sanayii AS, Arcelik, and TAV Airports, for example, have had operations outside the country for many years. This, along with other factors, has proved sufficient to lift the ratings above that on the sovereign in many instances. As the Turkish sovereign rating is low, even a small exposure to a higher-rated sovereign could benefit the overall rating.

Finally, we see an increasing number of companies building large cash balances outside Türkiye, and this is another trend that could support an increase in the number of companies that we can rate above the sovereign. As liquidity is a key consideration in our assessment of a company's capacity to withstand a sovereign default, large external cash balances could help companies pass the sovereign default stress test and meet our criteria for a rating above the sovereign.

Related Research

• Research Update: Turkiye Outlook Revised To Positive From Stable On Subsiding Twin Deficits; 'B' Ratings Affirmed, Nov. 30, 2023