21-May-2015 4:11 PM

Pegasus Airlines and Turkish Airlines: improved 1Q2015 margins thanks to lower fuel prices

Analysis

Both of Turkey's two largest airlines reported improved results and operating margins in 1Q2015 against the same period a year earlier. Both remained loss-making at the operating level in this seasonally weak quarter, although Turkish recorded a net profit as a result of foreign exchange gains on the revaluation of debt.

As is often the case, currency movements had a significant impact on the results of both airlines. For Pegasus, unit revenue reported in its functional currency, EUR, benefited from that currency's weakening against both TRY and USD.

For Turkish Airlines, unit revenue in its functional currency, USD, was adversely affected by the strengthening of that currency against EUR and TRY, which account for the majority of its revenue. Overall, both managed to increase their margins mainly as a result of lower fuel prices.

Summary

Both Turkish Airlines and Pegasus Airlines reported improved results and operating margins in 1Q2015 compared to the same period in the previous year.
Currency movements had a significant impact on the results of both airlines, with Pegasus benefiting from the weakening of the Euro against the Turkish Lira and the US Dollar.
Pegasus achieved a larger improvement in operating margin compared to Turkish Airlines, but both airlines remained loss-making at the operating level.
The functional currency for Turkish Airlines is USD, while Pegasus Airlines uses EUR, which affected their revenue and cost figures.
Both airlines saw their unit revenue (RASK) decline, but the decline in costs (CASK) was greater, resulting in improved operating margins.
Pegasus Airlines' unit revenues may be benefiting from a less aggressive competitive environment at its Istanbul Sabiha Gokcen base.

Pegasus had the bigger margin improvement

Pegasus achieved the bigger year on year improvement in operating margin, increasing its operating profit as a percentage of sales by 6.2ppts, compared with THY's 1.2ppt improvement. However, Pegasus' operating margin of -15.9% remained significantly weaker than THY's -3.2%. Pegasus is typically the more profitable of the two in the summer months and its FY2014 margin of 8.0% compared favourably with THY's 5.4%.

Turkish Airlines summary 1Q results (TRY million)

	1Q2014	1Q2015	*Change*
Revenue	5,128	5,457	6.4%
Operating profit	-226	-176	-22.1%
Operating margin %	-4.4	-3.2	1.2ppts
Net profit	-102	153	-250.0%

Pegasus Airlines summary 1Q results (TRY million)

	1Q2014	1Q2015	Change
Revenue	511	583	14.2%
Operating profit	-113	-93	-18.0%
Operating margin %	-22.2	-15.9	6.2ppts
Net profit	-105	-81	-22.8%

Neither airline uses TRY as its functional currency

An aspect of the results of both airlines that demands some consideration is the impact of foreign currency movements. For both, the Turkish lira (TRY) is the national currency, but THY's functional currency is USD and that of Pegasus is EUR. The functional currency is the one management uses to prepare its accounts, before translating into TRY for its financial statements. Both regard their financial results in their functional currency as reflecting the underlying economic position of the airline.

Although revenue increased for both in TRY (THY revenue +6.4% and Pegasus revenue +14.2%), the original functional currency figures moved somewhat differently. THY's USD revenue performance was weaker than in TRY, falling by 4.1%. By contrast, Pegasus' EUR revenue grew by 24.9%, faster than its TRY revenue growth.

Turkish Airlines summary 1Q results (USD million)

	1Q2014	1Q2015	*Change*
Revenue	2,315	2,219	-4.1%
Operating profit	-103	-70	-32.0%
Operating margin %	-4.4	-3.2	1.3ppts
Net profit	-226	373	-265.0%

Pegasus Airlines summary 1Q results (EUR million)

	1Q2014	1Q2015	Change
Revenue	168	210	24.9%
Operating profit	-37	-34	-10.3%
Operating margin %	-22.2	-15.9	6.2ppts
Net profit	-34	-29	-15.6%

Only 19% of THY's revenue is in Turkish lira

These differences stem from the different currency mix of revenue and costs for each airline and because their different functional currencies moved in opposite directions against TRY in 1Q2015 versus 1Q2014.

For Pegasus in 1Q2015, the largest segment of revenue was in TRY (46%), while its EUR revenue accounted for 41%. Whereas TRY had been weakening against EUR since early 2013, in 1Q2015 the Turkish currency enjoyed a year on year strengthening against the European single currency. This means that revenue earned in TRY translated into a higher number of EUR and so Pegasus' EUR-reported revenue growth was higher than its TRY-translated revenue growth.

For THY, 1Q2015, only 19% of revenue was in its functional currency USD, while 39% was in EUR, 13% in TRY and 29% in a variety other currencies. Both EUR and TRY - accounting for the majority of THY's revenue - weakened year on year against USD during the period. This meant that THY's USD-reported revenue growth was weaker than its TRY-translated revenue performance.

Pegasus Airlines and Turkish Airlines breakdown of revenue and cost by major currency

USD accounts for more than half of costs for both Pegasus and Turkish

THY's USD-reported costs fell by 5.3% in 1Q2015, whereas its TRY-translated costs actually grew at a similar rate. USD accounted for the largest proportion of THY's costs (51%) and the strengthening of USD versus TRY meant that this element of costs translated into a higher TRY number.

For Pegasus, costs reported in EUR grew by 18.5%, while TRY-translated costs grew by only 8.3%. Both USD (which accounted for 53% of its 1Q2015 costs) and TRY (19%) strengthened against EUR year on year, inflating these costs in EUR terms.

Year on year percentage change in Turkish Lira (TRY) versus USD and EUR by quarter 1Q2013 to 1Q2015

RASK grew faster than CASK for both, thanks to lower fuel prices

Calculating RASK and CASK in the functional currency for each (USD for THY and EUR for Pegasus), we see both RASK and CASK falling for THY, but increasing for Pegasus. The key to improved operating margins for both airlines was that the year on year growth in RASK outperformed the growth in CASK in 1Q2015. However, ex fuel CASK increased more rapidly than RASK for both and margins would not have improved without lower fuel prices.

Pegasus Airlines and Turkish Airlines year on year change in RASK, CASK and ex fuel CASK 1Q2015 versus 1Q2014*

	Turkish (USD)	Pegasus (EUR)
RASK	-12.4%	6.4%
CASK	-13.5%	0.9%
CASK ex fuel	-6.3%	9.0%

Although THY's USD-reported unit revenue decline accelerated in 1Q2015 relative to 4Q2014 due the weakening (against USD) of the currencies accounting for the majority of its revenues, it has now enjoyed a positive spread in RASK growth versus CASK growth for three successive quarters.

For Pegasus, EUR-reported unit revenue growth has accelerated due to the strengthening of both TRY and USD (which accounted for a combined 56% of its revenue in 1Q2015). 1Q2015 provided Pegasus with its first significantly positive RASK-CASK spread since 2Q2013.

Turkish Airlines year on year growth in USD-reported RASK and CASK by quarter 1Q2013 to 1Q2015

Pegasus Airlines year on year growth in EUR-reported RASK and CASK by quarter 1Q2013 to 1Q2015

Pegasus' unit revenues may also be benefiting from a less aggressive competitive environment at its Istanbul Sabiha Gokcen base.

Moreover, its 1Q2015 ASK growth of 17.4% was less than its original FY2015 guidance of 18% to 20% and it has now modestly lowered this full year guidance on capacity growth to a range of 17% to 19%.

As CAPA noted in a previous report, it is in the interests of both Pegasus and Turkish Airlines to avoid a price war at Sabiha Gokcen. For now, it seems that they are avoiding one.