09-May-2013 8:15 PM

Pegasus Airlines: a true LCC growing traffic and earnings at a winged gallop

Analysis

Shares in Turkish LCC Pegasus Airlines commenced trading on 26-Apr-2013 after an IPO that raised TRY649 million (EUR277 million). The IPO prospectus reveals that Pegasus is not only Europe's second most profitable airline (based on 2012 operating margin), but also one of its fastest growing (2008-2013 CAGR in passenger numbers of 33% p.a.). Its unit costs (CASK) place it with Wizz Air and Ryanair as one of Europe's three truly low-cost carriers.

Although Turkey was not immune to recession in 2009, air traffic continued to grow and Pegasus is still on a structural volume growth path not led by the economic cycle. Such a path does not guarantee earnings growth and Pegasus made a loss in 2011. Nevertheless, its low costs and strong presence in fast-growing Turkey and Central/Eastern Europe, should allow it to grow earnings in the future. Indeed, its breakeven operating result for the core business for the traditionally loss-making first quarter (reported 09-May-2013), with RASK up sharply and CASK falling, augurs well for FY2013.

Summary

Pegasus Airlines is Europe's second most profitable airline and one of its fastest-growing carriers.
The airline reported improved results in 1Q2013, with a reduced net loss and a breakeven result for the core business.
Turkey is one of Europe's fastest-growing aviation markets, driven by strong GDP growth and under-penetration of aviation.
Pegasus' growth has outpaced the Turkish market, with a CAGR in passenger numbers of 33% p.a. from 2008 to 2012.
The airline has a significant presence in Central and Eastern Europe, which has contributed to its growth.
Pegasus operates an all-Boeing fleet but has an order for 75 Airbus A320neo family aircraft for delivery from 2015.

Pegasus reports improved results for 1Q2013

In 1Q2013, Pegasus reduced its net loss from TRY106 million (EUR45 million) last year to TRY6 million (EUR3 million). The group operating loss narrowed by TRY82 million to a loss of TRY2 million (EUR1 million). The core Pegasus operation (excluding airberlin Turkey operations) achieved a breakeven result (TRY1 million), turning around a TRY70 million loss from 1Q2012. The core business saw revenues grow by almost 45% to TRY377 million (EUR160 million) on ASK growth of 26%, with RASK up 15% and CASK down by 10% (down almost 12% ex fuel).

Pegasus Airlines financial and operating highlights: 1Q2013

TRY million except where stated	1Q2012	1Q2013	Change
Total revenue	278.9	386.0	38.4%
Operating costs	362.9	387.9	6.9%
Operating profit*	-84.0	-1.9	+82.1 million
Operating margin %	-30.1	-0.5	29.6 ppts
Net profit	-105.7	-6.3	+99.4 million
Pegasus operation revenue	260.5	377.2	44.8%
Pegasus operation costs	330.8	376.2	13.7%
Operating profit Pegasus operation*	-70.3	1.0	+71.3 million
Operating margin Pegasus operation %	-27.0	0.3	27.3 ppts
Total passengers million	2.54	3.25	28.1%
Passenger Load Factor %	74.2	78.3	+4.0 ppts
ASK million	2,967	3,743	26.2%
RASK kurus	8.78	10.08	14.8%
CASK kurus	11.15	10.05	-9.9%
EX-fuel CASK kurus	6.67	5.90	-11.5%

Pegasus was Europe's second most profitable airline in 2012

Pegasus completed its IPO in Apr-2013 and the English version of the IPO prospectus has recently been made available on the company's website. It reveals that, in 2012, Pegasus increased its net result to TRY126 million (EUR55 million), turning around a loss of TRY14 million (EUR6 million) in 2011. The group's operating profit grew by almost TRY194 million to reach TRY188 million (EUR82 million), with an operating margin of 9.8%. Revenues grew by 29% to reach TRY1,920 million (EUR833 million), driven by ASK growth of 10% and RASK growth of 11%.

Excluding the airberlin Turkey operation (under which Pegasus group company IzAir operated split charter flights between Antalya and selected cities in Germany under the "airberlin Turkey" brand until this was recently suspended on the agreement of all parties), the operating result improved by TRY197 million to TRY198 million (EUR86 million) with a margin of 11.1%. Whichever version of its operating profit we use, Pegasus was Europe's second most profitable airline in 2012 by operating margin.

Pegasus Airlines financial and operating highlights: 2012

TRY million except where stated	2011	2012	Change
Total revenue	1,484.1	1,919.9	29.4%
Operating costs	1,489.5	1,731.5	16.3%
Operating profit	-5.4	188.4	+193.8 million
Operating margin %	-0.4	9.8	10.2 ppts
Net profit	-14.1	126.3	+140.4 million
Pegasus operation revenue	1,468.6	1,791.8	22.0%
Pegasus operation costs	1,467.6	1,593.6	8.6%
Operating profit Pegasus operation	1.0	198.2	+197.2 million
Operating margin Pegasus operation %	0.1	11.1	11.0 ppts
Cash and equivalent	19.5	210.2	190.7
Net debt	1,302.5	1,216.7	-85.8
Total passengers million	11.3	13.6	19.8%
Passenger Load Factor %	75.5	78.2	+2.7 ppts
ASK million	14,956	16,429	9.8%
RASK kurus	9.82	10.91	11.1%
CASK kurus	9.81	9.70	-1.1%
EX-fuel CASK kurus	5.73	5.42	-5.4%

But it made a loss as recently as 2011

Between 2010 and 2012, Pegasus' revenues almost doubled, while group operating profit increased more than five-fold, although the middle year, 2011, saw losses. The 2011 result was negatively affected by the start of the airberlin Turkey operation, but the operating profit of the core Pegasus operation was only TRY1 million.

Pegasus Airlines operating profit, net profit (left hand axis, TRY million) and revenue (right hand axis, TRY million): 2010 to 2012

Turkey is one of Europe's fastest growing aviation markets

Turkey is one of the fastest growing aviation markets in Europe, with compound average annual growth of 14% in total passenger numbers, 24% in domestic passenger numbers and 11% in international passengers from 2003 to 2012, according to figures from DHMI. This growth has been driven by relatively strong GDP growth (although Turkey was not immune to recession, seeing negative GDP growth in 2009 - when passenger growth nevertheless remained positive) and by the under-penetration of aviation in Turkey.

Passenger volume growth in Turkey vs real GDP growth

Aviation penetration in selected countries (total passengers/population): 2011

Moreover, Turkey is one of the world's most popular destinations by arrivals and has enjoyed a high growth rate in both arrivals and departures (see chart below).

Most popular arrival and departure destinations globally*

Pegasus is growing even faster than the Turkish market

Even in the context of the high-growth Turkish market, Pegasus' growth has been impressive. From 2008 to 2012, it enjoyed CAGR in passenger numbers of 33% p.a. (versus 12% p.a. for Turkey as a whole). Growth in international scheduled passenger numbers was 44% p.a. and domestic passenger numbers grew at a CAGR of 35%, while charter traffic declined at 12% p.a. Domestic passengers were 63% of total scheduled passenger numbers in 2012, the same as in 2011 (but they were 69% in 2008). Passenger load factor, which dipped in 2010 and 2011, recovered by 2.7 ppts in 2012 to reach 78.2%.

Pegasus Airlines development of passenger numbers (left hand axis, million) and passenger load factor (right hand axis, %): 2008 to 2012

Strong traffic growth has continued into 1Q2012, which saw total passenger numbers up 28%, ASKs up 26% and load factor increase by 4.0ppts to 78.3%. Growth was faster on international routes. The airline says that its plan for 2013 is to grow passenger numbers by 15%, suggesting a slower rate over the remaining quarters.

Pegasus traffic and operating statistics: 1Q2013

Significant presence in Central and Eastern Europe

Compared with the typical European LCC, Pegasus has more capacity in the faster growing Central and Eastern Europe (not surprising given its location) and this has also helped to drive its growth. Innovata data for the week of 6-May-2013 show that it has 42% of its international seat capacity in Eastern/Central Europe and that it is the fourth ranked airline in seat capacity in Eastern/Central Europe (behind Turkish Airlines, Aeroflot and Ryanair.

Its future growth strategy will focus on destinations to the east, north and south of Turkey, in particular the Middle East, North Africa, Central/Eastern Europe and the CIS, in addition to domestic routes. New international routes for the summer 2013 schedule include Antalya to Pristina and Istanbul Sabiha Gökçen to Nuremberg, Barcelona, Doha and Athens. Pegasus is also increasing frequencies to Tel Aviv, Belgrade, Sarajevo, Skopje and Lviv.

Pegasus Airlines international capacity (seats) by region: 6-May-2013 to 12-May-2013

Sabiha Gökçen hub, 70 destinations

Pegasus' principal hub is Istanbul's Sabiha Gökçen Airport, from which it operates to most of its 70 destinations (29 domestic and 41 international), and additional hubs at Adana, Antalya and Izmir. It operates international routes from these hubs and from Ankara, Kayseri, Kanya, Bodrum and Dalaman.

In 2012, its share of international passenger volumes to and from Turkey was 8.1% (versus 6.9% in 2010) and its domestic passenger share was 25.7% (versus 19.6% in 2010). Sabiha Gökçen had 14.9 million passengers in 2012 and a terminal capacity of 25 million, suggesting further growth potential. Pegasus had a 66.3% share of domestic flights and 67.5% of international flights at Sabiha Gökçen in 2012.

Pegasus Airlines top 10 hubs by seats: 6-May-2013 to 12-May-2013

Pegasus international route map: Apr-2013

Pegasus domestic route map: Apr-2013

Pegasus top five international routes by passenger numbers: 2010 to 2012

Pegasus top five domestic routes by passenger numbers: 2010 to 2012

Group revenues up 29% in 2012

Pegasus' Group revenue growth of 29% in 2012 was driven by 31% growth in domestic revenues and 58% growth in ancillary revenues. The core Pegasus operation saw revenue growth of 22%, while the airberlin Turkey operation's revenues grew more than eight-fold to account for nearly 7% of group revenues. The strong growth in ancillaries took its share of group revenues to 12%, while its share of core Pegasus revenues was 12.8%, up from 9.9% in 2011. In spite of the growth, this remains below the approximately 20% of revenues achieved by Ryanair and easyJet and Pegasus has identified ancillaries as a focus for further growth.

Pegasus Airlines revenues (TRY million): 2010 to 2012

	2010	2011	2012	Change 2012 vs 2011	% of 2012
International flight revenue	430.3	649.9	807.3	24.2%	42.0%
Domestic flight revenue	313.4	474.4	622.6	31.2%	32.4%
Scheduled flight revenue	743.8	1,124.4	1,429.9	27.2%	74.5%
Ancillary revenue	94.1	146.0	230.2	57.7%	12.0%
Charter revenue	128.3	179.2	106.7	-40.5%	5.6%
Other revenue	11.7	19.0	25.0	31.6%	1.3%
Pegasus operation revenue	977.9	1,468.6	1,791.8	*22.0%*	*93.3%*
airberlin Turkey operation revenue	-	15.5	128.1	726.5%	6.7%
Total revenue	977.9	1,484.1	1,919.9	*29.4%*	*100.0%*

A hybrid distribution model

Pegasus has low fares and a single class cabin, but, unlike the 'purist' LCC model practiced by the likes of Ryanair, it still sells around half of its tickets through travel agents, although this proportion is falling. Moreover, while its website is an increasingly important means of distribution, it is making growing use of the GDS channel. As direct sales channels grow, this should provide further cost savings. The carrier also operates a loyalty programme 'Pegasus Plus'.

Pegasus distribution channels by percentage of tickets sold

Cost growth was less than revenue growth in 2012

Pegasus saw group operating costs grow by 16% in 2012. The core Pegasus operation's costs grew by just under 9%, below capacity growth and considerably below revenue growth. The biggest cost item was jet fuel, 44% of the core operation's costs in 2012, which increased by 15%. Personnel costs (12% of the total) grew by 22%. Although year end headcount was stable, average headcount (calculated from year end figures) was up almost 10% and employee costs per employee were also up 10%.

Pegasus Airlines operating costs (TRY million): 2010 to 2012

	2010	2011	2012	Change 2012 vs 2011	% of 2012
Jet fuel	337.9	610.6	702.4	15.0%	44.1%
Personnel	121.2	162.2	197.6	21.8%	12.4%
Handling	75.4	99.8	111.2	11.4%	7.0%
Depreciation and amortisation	39.5	75.8	104.4	37.7%	6.6%
Navigation	71.6	101.8	103.2	1.4%	6.5%
Operating lease	78.4	111.6	84.8	-24.1%	5.3%
Sales & marketing	34.3	60.9	71.8	17.9%	4.5%
Maintenance	78.5	109.1	70.0	-35.9%	4.4%
Landing	24.2	35.6	39.7	11.5%	2.5%
Passenger service & catering	15.4	18.9	20.1	6.3%	1.3%
Other	65.3	81.2	88.5	9.1%	5.6%
Pegasus operation costs	941.7	1,467.6	1,593.6	*8.6%*	*100.0%*
airberlin Turkey costs	-	21.9	137.9	529.7%
Total	941.7	1,489.5	1,731.5	*16.3%*

Labour productivity is very competitive

In spite of the increase in labour costs, which was 24% when converted into euros, Pegasus' labour productivity is very competitive against other European carriers. We calculate its 2012 employee cost per employee to be just under EUR42,000, the second lowest in Europe (above only Wizz Air), reflecting the lower wage environment of countries in the eastern part of Europe. Labour costs are only 11% of revenues for Pegasus, ranking it fifth on this measure.

Pegasus' ATK per employee ranks sixth among the 20 carriers we have analysed (just ahead of its local rival Turkish Airlines in seventh, but behind the five other LCCs), while it ranks third on employee costs per ATK (behind Wizz Air and Ryanair). This strong performance on labour cost productivity is not matched in terms of revenue productivity: its revenue per employee of almost EUR380,000 ranks 10th (but this beats Turkish Airlines in 12th place).

Pegasus Airlines labour productivity measures

	2011	2012	Change
Average headcount	1,871	2,048	9.5%
Total labour cost EUR million	69	86	24.3%
Employee cost per employee (EUR)	36,883	41,877	13.5%
ATK ('000) per employee	800	802	0.4%
Employee costs per ATK (EUR cent)	4.61	5.22	13.1%
Revenue per employee EUR	333,902	379,742	13.7%

All-Boeing fleet to be joined by A320neo family from 2015

Pegasus has an all-Boeing narrowbody fleet with an average age of 3.7 years at the end of 2012. As at 19-Apr-2013, Pegasus had five outstanding orders for Boeing 737-800NG aircraft, which it expects to finance through sale and leaseback. It has not yet made a decision on the financing of the Airbus order, placed in Jul-2012, for 75 new aircraft comprising 57 A320neo and 18 A321neo (plus options for 25 further aircraft) for delivery from 2015. At the end of 2012, 13 of its 40 aircraft were on operating leases, down from 18 at the end of 2011. Its current fleet plan sees aircraft numbers at year end 2013, 2014 and 2015 as 44, 47 and 42 respectively.

Operating a dual fleet may lead to some initial inefficiencies in terms of maintenance costs, crew training and rostering (but presumably Pegasus expects these to be offset by the lower fuel burn of the A320neo family and the undisclosed price it obtained for the aircraft).

Pegasus fleet at year end: 2010, 2011, 2012

Pegasus projected aircraft deliveries: 2013 to 2022

RASK has outgrown CASK since 2010 (but not in 2011)

The chart below shows the development of Pegasus' unit revenues and unit costs from 2010 to 2012 (excluding the airberlin Turkey operation). What is striking is that RASK has grown by 35% over two years in spite of a 36% increase in ASKs. This suggests a good level of pricing power, perhaps because Pegasus' fares are much lower than those of its competitors.

Its average revenue per passenger in 2012 was EUR57, half that of local rival Turkish Airlines on its short- and medium-haul network. This average revenue per passenger is also fractionally below Ryanair's, making it the lowest for any European airline (although its average sector length is some 20% or more shorter than Ryanair's). Its low fares stimulate demand and still allow unit revenue growth as the gap to competitor fares remains wide.

Pegasus' unit costs (CASK) jumped by 26% in 2011, only partly due to fuel prices - ex fuel CASK was still up by 15%. This was exacerbated by the rise in the euro against the Turkish Lira, since a significant proportion of employee costs are paid in euros, and the growth in the fleet in 2011. The rise in CASK outstripped the RASK increase, leading to an operating result for the core Pegasus operation of only just above breakeven. However, both CASK and ex fuel CASK fell in 2012, while RASK continued to grow, leading to improved profits.

Pegasus Airlines index of revenue per available seat kilometre (RASK) and cost per available seat kilometre (CASK): 2010 to 2012 (indexed to 2010 = 100)

Pegasus joins Ryanair and Wizz Air in the ranks of truly low-cost carriers

The chart below compares unit costs with average sector length for a number of European and other carriers. Placing Pegasus on this chart clearly demonstrates that it has a very low cost structure, with only Wizz Air and Ryanair having lower costs per available seat kilometre. Since its route structure is shorter, it can be expected to have a higher CASK. Its cost base is significantly lower than those of the other European LCCs Vueling, Norwegian and easyJet.

Importantly, we estimate that Pegasus has unit costs that are 38% below those of Turkish Airlines on short/medium-haul. This cost advantage, built on an efficient labour force, coupled with Pegasus' position in the fast-growing Turkish and Central/Eastern European markets, give it a strong position for future earnings growth.

Unit costs (cost per available seat kilometre, EUR cent) and average sector length for selected European legacy and low-cost carriers: 2012*