19-Aug-2014 5:49 PM

Pegasus Airlines' fourth successive fall in underlying quarterly profit, but perhaps turned a corner

Analysis

Although Turkish LCC Pegasus Airlines reported a year on year increase in 2Q net profit, the underlying operating result was less than the same period last year. This was the fourth successive quarter of year on year declines in the underlying operating result.

Reading Pegasus' results is complicated by foreign exchange movements, since the majority of its revenues and, particularly, its costs are denominated in hard currency (mainly EUR and USD). Expressed in EUR terms, rather than in Pegasus' reporting currency of TRY, Pegasus lowered its CASK (cost per available seat km) in 2Q, but not enough to compensate for the drop in RASK (revenue per available seat km).

Nevertheless, Pegasus reiterated its FY2014 guidance amid some signs that it may have turned a corner and be ready to leave the path of deteriorating margins.

Summary

Pegasus Airlines reported a 72% increase in net profit for 2Q2014, but the underlying operating result declined.
The decline in the underlying operating result was the fourth consecutive quarter of year-on-year declines.
Pegasus Airlines' revenues increased by 33% in 2Q2014, driven by international scheduled flight revenue and strong growth in ancillary revenues.
The airline's capacity growth continued in 2Q2014, with ASKs up 22.1%, but the load factor remained flat at 79.9%.
Pegasus Airlines' costs increased by 41.8% in 2Q2014, outpacing the growth in revenues and ASKs.
The weakening of the Turkish lira against the USD negatively impacted Pegasus Airlines' operating profit due to its significant USD exposure.

2Q net profit up 72%, but underlying operating result falls

In 2Q2014, Pegasus Airlines grew its net profit by 72% compared with the same period a year earlier to post a figure of TRY87 million (EUR30 million). Revenues increased by 33% to TRY800 million (EUR276 million). The net profit was boosted by foreign exchange movements both from operating activities and from financing activities.

A truer reflection of the underlying performance of the business can be seen in the operating profit before other operating income and expense (which excludes these currency effects). This figure fell by 16% to TRY81 million (EUR28 million).

For 1H2014, the net result slipped from a profit of TRY44 million (EUR19 million) last year to a loss of TRY18 million (EUR6 million) this year. The 1H operating profit before other operating income and expense fell from a profit of TRY95 million (EUR40 million) to a loss of TRY32 million (EUR6 million). 1H revenues grew by 33% to TRY1,311 million (EUR442 million).

Pegasus Airlines financial and operating highlights: 2Q2014 and 1H2014

TRY million except where stated	2Q2013	2Q2014	Change	1H2013	1H2014	Change
Total revenue	603.9	800.4	32.5%	989.9	1,311.2	32.5%
Operating costs	507.1	719.1	41.8%	894.9	1,344.5	50.2%
Operating profit*	96.8	81.2	*-16.1%*	95.0	-32.1	*-133.7%*
Operating margin %	16.0	10.1	-5.9ppts	9.6	-2.4	-12.0ppts
Net profit	50.5	86.6	71.5%	44.2	-17.9	-140.5%
Pegasus operation revenue*	603.9	800.4	32.5%	981.1	1,312.5	33.8%
Pegasus operation costs*	507.1	719.1	41.8%	883.2	1,344.5	52.2%
Operating profit Pegasus operation**	96.8	81.2	*-16.1%*	97.9	-32.1	*-132.8%*
Operating margin Pegasus operation %	16.0	10.1	-5.9ppts	10.0	-2.4	-12.4ppts
Total passengers million	4.30	5.17	20.2%	7.55	9.24	22.4%
Passenger Load Factor %	80.0	79.9	-0.1ppts	79.3	79.4	0.1ppts
ASK million	5,214	6,367	22.1%	8,957	11,174	24.8%
RASK kurus	11.58	12.57	*8.5%*	10.94	11.73	*7.2%*
CASK kurus	9.73	11.29	*16.1%*	9.86	12.03	*22.0%*
EX-fuel CASK kurus	5.72	6.69	17.1%	5.79	7.26	25.2%

ASK growth of 22%, load factor flat

Pegasus continued its strong capacity growth in 2Q2014, with ASKs up 22.1%, slightly slower than the 28.4% growth in 1Q2014. Although growth was stronger in international markets than in the domestic market, the difference was not as pronounced as it had been in 1Q2014.

Passenger load factor was flat (-0.1 ppts) at 79.9% for 2Q2014, a figure that is broadly equal to that of Europe's full service carriers (as represented by the Association of European Airlines), but short of the load factors achieved by most of its principal LCCs. The load factor on the international network fell by 1.2ppts to 76.3% in 2Q and this looks to be an area of considerable scope for improvement.

Pegasus increased its total number of destinations by 18% year on year to 84 and will have launched nine new destinations during summer 2014 (Madrid, Frankfurt, Kuwait, Mineralnye Vody, Prague, Geneva, Bahrain, Hamburg and Budapest). It also moved its Belgian operation from Brussels Airport to Brussels South Charleroi.

It increased frequencies on a further 18 routes, but a considerable proportion of Pegasus' capacity growth is coming from new routes and this appears to be having a weakening impact on load factors for now.

CFO Serhan Ulga told analysts on a conference call to discuss the 2Q results that Pegasus was seeing load factor improvements of around 1ppt in its bookings for the late summer months in the domestic market. In international markets, he said there continued to be a small fall in load factor, but yields were recovering.

Pegasus Airlines traffic statistics: 2Q2014 and 1H2014

Pegasus' 2Q revenues were up 32.5%

Pegasus' 2Q revenue growth of 32.5% was faster than the growth in ASKs. This was mainly driven by international scheduled flight revenue, which grew by 37.8% and accounted for 44% of total revenues. Domestic scheduled revenue growth of 20.2% was broadly in line with domestic ASK growth.

Ancillary revenues grew strongly, up 66% year on year, and increased their share of 2Q revenues from 13% in 2013 to 17% in 2014. Ancillary revenue per passenger grew by 38% to TRY25.76, although much of this growth can be attributed to the weakening of TRY versus EUR. In EUR, ancillary revenue per passenger grew by 14% to EUR8.90 in 2Q (up 12% to EUR8.92 for 1H). Pegasus continues to target EUR10-12 within the next three years and looks to be on course to achieve this.

Pegasus Airlines revenues: 2Q2014 vs 2Q2013

TRY million	2Q2013	2Q2014	Change	% of 2Q2014 total
Int'l scheduled flights	253.8	349.8	37.8%	44%
Domestic scheduled flights	210.2	252.6	20.2%	32%
Total scheduled flight revenue	464	602.5	29.8%	75%
Ancillary revenue	80.2	133.2	66.0%	17%
Charter revenue	46.1	49.4	7.2%	6%
Other revenue	13.6	15.3	12.5%	2%
Pegasus operation revenue	603.9	800.3	*32.5%*	100%
AirBerlin Turkey operation revenue	0	0	-	0%
Total revenue	603.9	800.3	32.5%	100%

RASK up 8.5% in TRY, but down 10.1% in EUR

Total revenue per ASK grew by 8.5% in 2Q, an acceleration on the 5.7% increase in 1Q. However, this increase in TRY-reported RASK was boosted by the weaker TRY against the EUR.

In EUR terms, RASK fell by 10.1% and this better reflects the market environment, particularly in the competitive international markets operated by Pegasus. While still weak, the fall in EUR RASK was less severe than the 17.9% decline suffered in 1Q2014. The competitive impact on pricing of Turkish Airlines' expansion into Pegasus' Sabiha Gokcen hub appears to be easing.

2Q costs up 41.8%

Operating costs increased by 41.8% in 2Q, faster than the growth in revenues and ASKs. Fuel costs, which accounted for 41% of the total, increased by 40% and ex fuel costs grew by 43%. Cost per ASK (CASK) increased by 16.1% in TRY-reported figures, but fell by 3.8% when expressed in EUR.

Pegasus Airlines operating costs: 2Q2014 vs 2Q2013

TRY million	2Q2013	2Q2014	Change
Fuel costs	209.0	292.9	40.1%
Labour costs	77.3	92.2	19.3%
All other costs	220.8	334.0	51.3%
Pegasus operation costs	507.1	719.1	41.8%
AirBerlin Turkey operation costs	-	-	-
Total costs	507.1	719.1	41.8%

TRY weakness versus USD is bad for profits

Pegasus' functional currency is the euro, but its reporting currency for its financial statements is the Turkish lira. The weakening of TRY had the effect of raising both RASK and CASK in its TRY-reported results relative to its EUR-denominated management accounts, but the impact on costs was greater than it was on revenues.

This was mainly due to the significant imbalance in Pegasus' USD exposure in its income statement. It has 54% of costs in USD, but only 13% of revenues (1H2014, source: Pegasus), so a weaker TRY versus USD lowers its operating profit.

Its EUR exposure is greater on the revenue side (39%) than on the cost side (26%). This means that a weaker TRY versus EUR actually increases operating profit, but the impact is less significant than the USD impact.

Pegasus Airlines P&L sensitivity to currency movements and fuel prices (TRY million): 1H2014

FY2014 guidance unchanged

Pegasus has not changed its guidance and targets for FY2014. It plans 20% growth in ASK and passenger numbers and an EBITDAR margin in the range 17% to 19% (it achieved 22.3% in 2013).

Pegasus' 1H2014 EBITDAR margin roughly halved to 10.6% versus 20.4% in 1H2013. Its FY2014 target implies that it will make a similar 2H EBITDAR margin this year to the 23.6% recorded in 2H2013.

Mr Ulga said that many of the costs that have burdened Pegasus in recent quarters were one-of in nature and should ease in future quarters. The outlook for CASK in EUR terms is "to remain stable for the near term", although it fell by 2.1% in 1H2014.

Pegasus may have turned a corner in 2Q2014

While both RASK and CASK increased year on year in TRY terms and both fell in EUR terms, the key point is that RASK performed more weakly than CASK in either currency and this was why the operating result deteriorated. 2Q2014 was the fourth consecutive quarter when the spread between RASK growth and CASK growth was negative.

More encouragingly, the rate of decline in EUR RASK eased in 2Q2014 versus 1Q2014 and EUR CASK once again fell after two quarters of small increases. The curve plotting the spread between RASK and CASK, while still negative, turned upwards in 2Q2014 after a period of sloping downwards (see chart below).

Although Pegasus expects lower margins in 2014 than in 2013, at least the RASK-CASK relationship stopped deteriorating in 2Q2014. This helps to give some reassurance that profitability could start to improve once more. The seasonally important 3Q, when the bulk of its profits are earned, will be the key to its achieving (or perhaps bettering) its 2014 target.

See related reports:

Pegasus Airlines year on year change in EUR-denominated RASK and CASK: 1Q2013 to 2Q2014