16-May-2014 4:56 PM

Turkish Airlines suffers bigger 1Q losses, but continues to focus on "profit, profit, profit"

Analysis

Turkish Airlines suffered wider losses in 1Q2014 as a drop in unit revenues negated the benefit of lower unit costs (both in USD terms). Capacity growth, in ASKs, was more than 21%, but revenues grew by only 15%. RASK was particularly weak in the domestic market, due to capacity growth (especially at Sabiha Gökçen, where it competes with LCC Pegasus) and currency weakness, and was also affected by the shift of Easter into April in 2014.

THY says that booking trends indicate a positive demand outlook and yield pressure should ease in 2H2014 after further weakness in 2Q2014. Losses in the seasonally weak first quarter are not unusual and the year 2014 should certainly end with THY in the black, but it looks likely to see a lower operating profit than in 2013.

No company that grows at double digit rates of volume growth can guarantee an ever upward path of profitability, but CEO Temel Kotil highlighted his priorities when he told analysts and investors at a presentation in Istanbul that the most important things were "profit, profit, profit".

1Q2014 net loss grows by more than 600%

In 1Q2014, Turkish Airlines saw its net loss widen to USD102 million from USD14 million in 1Q2013. The operating result was a loss of USD102 million, compared with a loss of USD48 million a year earlier. Revenues grew by 15% to USD2,315 million.

Note that, while THY's official reporting currency for its statutory accounts is TRY, its functional currency is USD and management prepares all accounts in USD before translating them into TRY for statutory reports. We will present our analysis using the USD figures provided by the Group.

Turkish Airlines summary profit and loss account (USD million): 2009 to 2013, 1Q2013 and 1Q2014

ASK growth of 21.5%, faster in the domestic market

In 1Q2014, THY increased its ASKs by 21.5%, while RPKs grew by 21.0% and passenger numbers were up 20.2%. Passenger load factor dipped by 0.3 ppts to 77.7%. Growth was faster in the domestic market, where ASKs were up 34% and passenger numbers 28%, than on international markets, where ASK growth was 20% and passenger growth 15%.

Domestic load factor gained 0.5 ppts, while international load factor fell by the same amount. In recent years, annual changes in overall load factor have been driven by international load factor and so THY will want to ensure that the 1Q2014 decline in the latter is not repeated through the rest of the year.

Within the international segment, THY grew capacity most rapidly to South America, where ASKs were up nearly 36%, and to the Far East, where ASKs were up almost 29%. In South America, demand growth did not match capacity growth and load factor fell by 4.5 ppts, albeit to a still high level of 80.3%. However, South America only accounted for 2% of total international scheduled ASKs and was not the main driver of the fall in international load factor.

There was also a pronounced decline in load factor to Europe, which represented 35% of international ASKs and where load factor was down 2.6 ppts to 74.2% on ASK growth of 18%. By contrast, load factor to North America gained 3.9 ppts to 82.7% on ASK growth of 20%.

Turkish Airlines passenger numbers (million): 2009 to 2013, 1Q2013 and 1Q2014

Turkish Airlines passenger traffic growth: 1Q2014 vs 1Q2013

Turkish Airlines passenger load factor (%): 2009 to 2013, 1Q2013 and 1Q2014

Growth in international to international transfer traffic continues to grow faster than the total

The number of international to international transfer passengers increased by 27%, faster than the growth in total passengers, and accounted for 26% of all passengers and 46% of all international passengers. This demonstrates the ongoing success of THY's strategy of using Istanbul as a hub to capture global connecting traffic, while retaining a solid base of domestic traffic (which accounted for 43% of passengers in 1Q2014).

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This strategy faces some constraints as Istanbul Ataturk starts to reach its capacity limits, pushing THY to place significant new capacity at Istanbul Sabiha Gökçen, which is home to LCC Pegasus Airlines. A connecting strategy works best with a single hub and so Ataturk should remain the principal hub for international to international connecting traffic, with Sabiha Gökçen playing a growing role in domestic point to point, domestic to international transfer and international point to point markets.

Turkish Airlines international to international transfer passengers ('000): 2009 to 2013, 1Q2013 and 1Q2014

Turkish Airlines passenger breakdown: 1Q2014

Revenues up 15%

USD revenue growth of 15% year on year in 1Q2014 did not match the 21.5% increase in ASKs. This was the result of the failure of scheduled passenger revenues to keep pace with the growth in scheduled ASKs. Cargo revenues grew by 22%, marking THY's cargo business out from other airline groups, where cargo has been in decline, although this was slower than the 27% growth in cargo tonnes.

Turkish Airlines revenues (USD million): 1Q2014 vs 1Q2013

USD million	1Q2013	1Q2014	Change	% of 1Q2014 total
Scheduled passenger revenue	1,768	2,009	13.6%	87%
Cargo	190	232	22.2%	10%
Charter	9	11	27.1%	0%
Other	48	64	32.8%	3%
Total revenue	2,015	2,315	14.9%	100%

Scheduled passenger revenue per ASK fell by 8% year on year, with THY citing a number of factors to explain this weakness. These included yield pressure relating to local currency depreciation in a number of regions, additional capacity at Istanbul Sabiha Gökçen, growth in the share of transfer passengers, the move in the timing of Easter from 1Q2013 to 2Q2014 and political tensions in Russia, Ukraine and Thailand.

This weakness was particularly felt in the domestic market, where USD revenues were flat in spite of a 34% increase in ASKs. Passenger RASK fell by 24% in the domestic market and by 5% in international markets. The domestic market is primarily a TRY market and so the plunge in USD-reported RASK owes much to the 19% fall in the average value of TRY versus USD from 1Q2013 to 1Q2014.

Turkish Airlines scheduled flight revenues (USD million): 1Q2014 vs 1Q2013

USD million	1Q2013	1Q2014	Change	% of 1Q2014 total
Europe	597.3	679.2	13.7%	30%
Far East	444.5	529.6	19.1%	24%
Middle East	283.9	331.3	16.7%	15%
America	184.1	216.7	17.7%	10%
Africa	172.3	208.8	21.2%	9%
Total international	1682.1	1965.6	16.9%	88%
Domestic	276.1	275.4	-0.3%	12%
Total scheduled flight revenue	1958.2	2241	14.4%	100%

Turkish Airlines capacity and unit revenue development by region: 1Q2014 vs 1Q2013

Yield pressures come from strong capacity growth at Sabiha Gökçen

Nevertheless, capacity increases at Sabiha Gökçen (SAW), resulting from the lack of airport capacity at Istanbul Ataturk, have increased the level of direct competition with LCC Pegasus Airlines and this has added to downward yield pressure in the domestic and Europe markets.

Mr Kotil said that capacity growth at SAW was the main reason for falling yields in 1Q2014, but that the Group needed to achieve "critical mass" of capacity at the airport.

This growth at SAW looks set to continue: according to data from OAG, Pegasus increased its number of seats at SAW serving Europe by 22% year on year in the week of 12-May-2014, while THY grew seat numbers by 74% in the same market. Pegasus' share of seats in this market from SAW is 71%, down from 76% for the same week a year earlier, while THY's share is up to 24% from 18%.

In domestic markets from SAW, Pegasus grew its weekly seat capacity by 21% and THY by 46% year on year in week of 12-May-2014. At the same time, THY also increased its seat capacity from Istanbul Ataturk to Europe and the domestic market by 12% and 14% respectively.

The Group will have 42 destinations from SAW in 2014, compared with 30 in 2013. Subsidiary brand Anadolujet is increasing the number of domestic routes from 16 to 22 at SAW and Turkish is increasing its European routes from 10 to 14.

Turkish Airlines Group key statistics at Istanbul Sabiha Gökçen: 2013 and 2014

Costs up 17%

Operating costs, in USD, increased by 17%, which was less than the increase in ASKs, but faster than the growth in revenues and this led to the lower operating result in 1Q2014. The growth in costs was moderated slightly by fuel cost growth of only 15%, while non-fuel costs increased by 18%. Labour cost growth was limited to just over 3% (helped by the weaker TRY versus USD), but landing, navigation and air traffic charges grew by 30% due to price increases. Passenger services and catering costs, up 29%, also grew faster than ASKs due to price increases and an enhanced catering concept.

Total operating cost per ASK (CASK) fell by 3.5%, with ex fuel CASK down 2.5%, but this was not enough to match the 5.4% drop in total RASK.

Turkish Airlines operating costs revenues (USD million): 1Q2014 vs 1Q2013

Fleet of 241 aircraft at the end of 1Q2014

THY's fleet consisted of 241 aircraft at the end of 1Q2014, of which 189 were narrowbodies, 43 widebodies and nine cargo aircraft. Its current fleet plan will see the total grow to 432 in 2021, slightly lower than the 435 target communicated at the time of its FY2013 results in Mar-2014.

The expansion will focus mainly on the narrowbody fleet, which is set to grow by 160 aircraft by 2021, while the widebody fleet is currently planned to grow by 33 aircraft.

THY has for some time been considering a further widebody order and so the widebody numbers could be revised upwards, but its fleet planning is driven by the fact that more than 40% of global international traffic is within narrowbody range of Istanbul.

Turkish Airlines fleet as of 1Q2014 and planned to 2021

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Turkish Airlines retains its strong strategic position, but carries a near term profit challenge

THY continues to capture a growing share of world passenger traffic flows and is driving forward with double digit growth in capacity and revenues. It already flies to more countries (207) than any other airline and will focus future growth in frequency increases. It is profitable and cost efficient compared with long-haul peers and its longer term future looks assured.

However, Turkish faces a near term challenge to increase its profitability. In FY2013, its operating margin (based on its USD accounts) fell from 7.5% to 5.9% as a fall in RASK was unable to offset a stable CASK. In 1Q2014, CASK fell but RASK fell further and THY has now had three successive quarters when the year on year growth in RASK has under-performed against the growth in CASK.

For the full year 2014, THY expects ASK growth of 21%, revenue growth of 19% and fuel costs up 19%. The key elements of its 2014 guidance are that it expects total CASK to fall by 2%, but total RASK to fall by 2.5%. In 1Q2014, ASK growth was in line with this and CASK did better (it fell 3.5%), but RASK was lower by a larger amount (it fell by 5.4%).

The guidance for RASK to fall more than CASK already suggests that THY will not increase its operating profit in 2014 relative to 2013. Although there are three quarters of the year still to come, the 1Q results make this challenge look even harder.

Turkish Airlines year on year growth in USD-reported RASK and CASK by quarter: 2013