Turkish Airlines SWOT: More growth for the Istanbul superconnector

TURKISH AIRLINES: STRENGTHS

1. THY is the largest airline in Turkey - a market with strong potential
According to data from OAG for the week of 01-Oct-2018, Turkey is Europe's number seven aviation market by total seat numbers and its third largest by domestic seats.
Turkey has one of Europe's highest populations (more than 80 million inhabitants) but is relatively underpenetrated by air travel, by comparison with the larger countries of Western Europe. This offers significant air traffic growth potential as Turkey's economy grows (in particular its level of GDP per head, which is below the European average).
According to data from Turkey's airport authority DHMI, the compound average growth rate in domestic passenger numbers from 2017 to 2020 will be 8.1% pa, and for international passengers it will be 8.9% pa.
THY is the leading airline in Turkey, with a seat share of 48.3% in the country's seasonal peak week of 03-Sep-2018 (more than double that of Pegasus Airlines, 18.6%), according to data from OAG.

Destinations within narrowbody and widebody range of Istanbul

Source: Turkish Airlines

2. THY's Istanbul hub location attracts global transfer traffic
THY takes advantage of the geographic location of its Istanbul hub to attract global transfer traffic.
Istanbul is within narrowbody range of more than 40% of global international traffic, including more than 60 national capital cities. The Middle East, Central Asia, North and East Africa and all of Europe are within narrowbody range. Out of THY's existing 255 international destinations, 201 are within narrowbody range of Istanbul.
Within widebody range of Istanbul are Upper South America, all of North and Central America, all of Asia and the west coast of Australia.
3. THY has a large global network, with particular strength in Europe
Compared with the big three Gulf airlines (Emirates, Qatar Airways and Etihad), who also have strategies based on attracting global transfer traffic flows, THY has a much stronger position in Europe.
In 1H2018, 56% of its international passengers were on routes to/from Europe. Moreover, for the week of 01-Oct-2018, OAG data indicate that THY has 103 international destinations in Europe - more than double the number operated by the nearest Gulf competitor (Qatar Airways has 51).
THY also has more destinations in Africa, Latin America and the Middle East than any of the Gulf three. However, its network is relatively light on destinations in Asia Pacific (see weaknesses below).
4. THY offers high levels of connectivity
According to data quoted by Turkish Airlines in its 1H2018 results presentation (source: OAG as at 31-Dec-2017), the airline has the highest connectivity by O&D pairs from Europe, Middle East, Africa and Far East to the world.
5. THY has an efficient level of unit cost
THY has a very efficient cost structure by comparison with most full service carriers. Its unit cost, expressed as cost per available seat kilometre (CASK) in US cents, is below the trend line for European FSCs on a scatter plot of CASK against average trip length. This (in addition to its hub location) gives it a further advantage against the European network airlines in competing for global traffic flows.
Moreover, THY's CASK is similar to that of Emirates and below Etihad's, but THY's average sector length is much shorter and (all other things being equal), this should give it a higher CASK than those of its Gulf based rivals.
6. THY has a young fleet
Turkish Airlines' average fleet age is 7.7 years at 01-Oct-2018, compared with an average of 14.0 years for all European airlines, 10.9 years for Middle East airlines, and 9.8 years for Asia Pacific airlines (source: CAPA Fleet Database).
The airline's relatively young fleet by comparison with those in its main regions of activity gives it an advantage in terms of fuel efficiency and customer appeal.

Turkish Airlines, Emirates, Qatar Airways, Etihad: number of nonstop destinations by region*

	Turkish Airlines		Emirates		Qatar Airways		Etihad
	Own aircraft	By codeshare	Own aircraft	By codeshare	Own aircraft	By codeshare	Own aircraft	By codeshare
Africa	42	32	23	12	19	47	8	45
Asia Pacific	31	49	48	119	55	69	34	141
Europe	103	77	42	80	51	103	20	152
Latin America	6	52	4	42	2	41	0	25
Middle East	29	7	14	20	14	5	9	4
North America	11	68	13	93	11	60	5	55
International total	222	285	144	366	152	325	76	422
Domestic total	45	3	1	1	1	1	1	1
Total	267	288	145	367	153	326	77	423

Source: CAPA - Centre for Aviation and OAG
Note: *Week of 1-Oct-2018

7. THY's strong growth has been profitable (mostly)
THY achieved a compound average growth rate in passenger numbers of 13.3% pa in the decade from 2007 to 2017. Growth slowed to 2.5% in 2016, when a series of geopolitical events adversely affected traffic demand to/from Turkey. Nevertheless, THY's growth in 2016 contrasted with a fall in the country's total passenger numbers that year.
Moreover, THY recovered with growth of 9.3% in 2017, and expects similar growth in 2018. Although its growth rate is slower than it was in the past, this still represents a strong rate by comparison with the mid single digit rates more typical of European and global airlines.
The group's fleet plan, published with its 1H2018 results, indicates a total fleet growing from 325 aircraft at the end of 2017 to 475 at the end of 2023, which is an average increase of 6.5% pa.
THY has achieved its growth while mostly also posting positive financial results, having reported profits in every year of the past decade with the exception of 2016, when it made a rare loss. In 2017 THY made an operating margin of 7.2%, marking a creditable recovery from its losses of 2016 and a return to the 6%-7% operating margin range it had consistently occupied in 2012 to 2015.

TURKISH AIRLINES: WEAKNESSES

1. THY's financial performance has been inconsistent in recent years
As noted above, THY fell into loss in 2016 as a result of the adverse demand impact of a series of terrorist events and an attempted coup in Turkey.
Although the airline took action at the time to reduce its capacity plan, it was unable to prevent losses in a year when the global airline industry achieved a record operating margin.

Cost per available seat kilometre (CASK, USc) versus average trip length for Turkish Airlines and trend lines for different business models*

Source: CAPA - Centre for Aviation and airline company accounts

2. THY's Asia Pacific network is small versus those of Gulf airlines
The section on strengths noted that THY has a strong global network. However, by comparison with the Gulf-based superconnectors, its Asia Pacific network is small when viewed by the number of destinations. Its lack of services to Australia is a particular gap by comparison with its Gulf competitors, although it is considering launching a Sydney service in summer 2019.
With 31 Asia Pacific destinations in the week of 1-Oct-2018, THY has fewer than each of Emirates (48), Qatar Airways (55) and Etihad (34).
Asia Pacific is the world's biggest aviation market by seats, ASKs and frequencies, and the second largest international aviation market after Europe. THY is strong in Europe, but does not balance this with its Asia Pacific presence.
There are two main reasons for this shortcoming. The first is due to the slight geographic disadvantage of Istanbul, which means that existing technology aircraft are unable to reach some of the distant destinations - notably Australia - with a commercial load; the other is Turkey's limited bilateral access to the Indian market, particularly poignant given Turkish's expansive US network.

TURKISH AIRLINES: OPPORTUNITIES

1. THY's brand could regain former heights
THY has a strong brand, but this is showing some signs of losing momentum. It was ranked as a top 20 world airline by Skytrax in 2018, when it was placed at number 18, although its ranking had slipped from 12th in 2017. Moreover, it had consistently been top 10 in the period 2012 to 2016 and was as high as fourth in 2015, beating all other European airlines.
In 2018 it was only the fourth highest European airline (after Lufthansa, SWISS and Austrian), and was ranked below all of the three Gulf superconnectors (Qatar Airways was ranked second, Emirates fourth and Etihad 15th).
THY won awards for best airline in southern Europe, best business class lounge, and best business class lounge dining, showing that it still has considerable strength as a premium brand. This could provide a platform from which to regain previous high global rankings.
2. Istanbul New Airport will provide much more growth potential
The opening of Istanbul New Airport in Oct-2018 will give Turkish Airlines a new hub, with vast expansion potential. Its Istanbul Atatürk hub is full and it has had to use Istanbul Sabiha Gökçen as an overspill base, to some extent compromising the efficiency of its transfer strategy.
In 1H2018, 42% of THY's passengers was transfer traffic (31% international to international, and 11% domestic to international). Clearly such a strategy, and the rapid growth that has accompanied it, can only continue with sufficient airport capacity. Subject to a smooth transfer of operations, the new airport should provide this.

Turkish Airlines revenue, net profit and operating profit* (USD million)

Source: CAPA - Centre for Aviation and Turkish Airlines

Turkish Airlines average daily aircraft utilisation (hours)*

Source: CAPA - Centre for Aviation and OAG

3. THY could make further load factor improvements
THY's passenger traffic recovery in 2017 was achieved with a very modest capacity increase (ASKs grew by 1.6%). This helped to boost its passenger load factor by 4.7ppts to 79.1% - almost back to its 2014 peak of 79.3%.
Nevertheless, with global average load factor now exceeding 80% (it was 81.4% in 2017, according to IATA), THY is below its peers on this measure.
In 1H2018 THY's load factor was 80.4%, a 4.3ppt gain year-on-year. It is aiming for 81% for the year, but has an opportunity to improve this further.
4. THY could improve its aircraft utilisation
THY's daily aircraft utilisation rate fell from 12:51hrs in 2015 to 11:42hrs in 2017. It consistently achieved a level of more than 12hrs from 2012 to 2015 and its 1H2018 rate increased to 11:56, but the Gulf three are typically in the range of 13hrs to 15hrs.
THY's relatively higher proportion of short and medium haul routes is a limiting factor, to some extent, but it has an opportunity to drive further improvements in aircraft utilisation.
5. THY's new widebody orders should enhance its network
THY has firm orders for 25 Boeing 787-9 aircraft for delivery between 2019 and 2022 and 25 Airbus A350-900s for delivery between 2020 and 2023 (source: CAPA Fleet Database, 02-Oct-2018).
Both these new generation aircraft have advantages of range and unit cost against THY's existing A330 widebodies. They should help it to open up new markets in regions such as Southwest Pacific and Latin America and increase its gauge flexibility in existing markets.
6. Further growth in cargo revenue could be achieved
In addition to the use of belly freight in its passenger aircraft, THY serves 82 destinations with 18 dedicated freighter aircraft, at a time when many leading European airlines have reduced or abandoned their use of freighters.
THY derived 12% of its revenue from cargo operations in 2017, which was an increase from just below 9% in the period 2013 to 2015. Nevertheless, this remains below the global average, which can be calculated from IATA data to be 12.7% in 2017.
In 1H2018 THY's cargo revenue grew by 35% and was 13.2% of total revenue, up from 12.6% in 1H2017. This suggests that THY has an opportunity to drive further increases in cargo revenue, taking advantage of its hub location as in the passenger business.
7. SunExpress could provide THY with an alternative growth platform
Together with Lufthansa, THY has a 50% stake in the LCC SunExpress, which flies between Europe (mainly Germany) and leisure destinations in Turkey. It also operates flights on behalf of THY's domestic subsidiary Anadolujet.
Its German subsidiary, SunExpress Germany, operates long haul flights under wet lease for Eurowings, the Lufthansa low cost subsidiary. THY could consider using SunExpress further as a platform with which to counter LCC competition on routes to Europe and elsewhere.
8. THY could increase the number of codeshare destinations
By comparison with the Gulf three, THY has fewer codeshare destinations to extend its network reach (partly because it already has more international destinations using its own aircraft).
Nevertheless, THY has 50 codeshare partners, compared with 22 for Emirates and 22 for Qatar Airways. Etihad has 53 codeshare partners, slightly more than THY, but its 422 international codeshare destinations are significantly more than THY's 285. This suggests that THY could consider making greater use of its codeshare partners to extend the number of destinations that it can offer its passengers.

TURKISH AIRLINES: THREATS

1. THY is exposed to Turkey's economic/geopolitical context
As demonstrated by financial losses in 2016, when geopolitical and terrorist events in Turkey weighed on demand, airlines operating in Turkey are exposed to economic and geopolitical risks to a greater degree than elsewhere in Europe.
More recently, the currency crisis that was sparked by a diplomatic row between Turkey and the US and hit the Turkish lira again, demonstrates the uncertainties of THY's exposure to macro risks. The country's President, Recep Tayyip Erdoğan, pursues policies that are seen as controversial by many observers.
See related report: Turkish Airlines & Pegasus: the slumping lira isn't all bad news
2. Airlines are vulnerable to external events
As with all airlines, THY is vulnerable to the risk of possible accidents, in addition to strikes and other events that could disrupt its service and adversely affect its reputation and demand for its services.
In addition to geopolitical risk (already mentioned), these could include natural phenomena such as earthquakes and volcanic ash disruption.
3. THY's costs will be burdened by rising fuel prices
Brent crude oil prices were back above USD80 per barrel in early Oct-2018, when jet fuel prices were close to one third higher than a year previously.
Rising jet fuel prices will place an additional burden on THY's cost base in 2018. According to its 1H2018 results presentation, it has hedged only 50% of its 2H2018 fuel requirements and just 22% of its 2019 requirements. Its 1H2018 results presentation predicted that it would have an average jet fuel price of USD700 per tonne in 2018 - an 18% increase on 2017.
4. Competition from Pegasus/LCCs is growing
According to data from OAG and CAPA, the LCCs' share of domestic seats in Turkey grew from 19.1% in 2007 to 35.8% in 2017. Their international share grew from 15.4% to 22.8% over the same timeframe.
According to data from Pegasus and Turkey's General Directorate of State Airports Authority, the ultra LCC Pegasus Airlines' share of passenger traffic in Turkey was 20% in 2017, up from 14% in 2012. The LCC's domestic share was 31%, compared with 26% five years earlier, and its international share was 12%, up from 8% in 2012.
According to CAPA calculations based on the airlines' financial and traffic results, Pegasus' 2017 CASK was 29% below that of Turkish Airlines, in spite of an average trip length that is 50% shorter.
5. Competition from the Gulf remains strong
THY faces continued competition from the Gulf-based airlines that are also using their hubs to attract global transfer traffic flows, even though they are not growing as rapidly as they once did.
The Gulf three (Emirates, Qatar Airways, Etihad) have a geographic advantage in attracting connecting passengers to/from Southern Asia and Australasia and have also been successful in developing high quality service and strong brands.
Conclusion: Turkish Airlines' growth to continue
Although each of Turkish Airlines and Pegasus has a significant advantage over the other (THY's market share and Pegasus' unit cost), their results demonstrate that they follow a similar profit cycle. This suggests that they both occupy different market segments, in which they each have a unit cost advantage over other competitors.
Against the Gulf superconnectors, THY has strengths in regions within narrowbody range of Istanbul and the advantage of a significant home market. It also has some advantages of geography for connecting passengers from Europe and North America - in particular to Africa and Northeast Asia - but disadvantages to Southeast Asia and Southwest Pacific. THY has a unit cost advantage over the Gulf airlines, but a slightly less highly regarded brand.
Although not totally insulated from risks, Turkish Airlines looks set to continue its growth path as one of a handful of truly global superconnectors.