Pegasus Airlines: FY operating loss now likely after more red ink in 2Q. Capacity growth slows

2Q operating margin falls by 13ppts

In 2Q2016, Pegasus' net result slumped to a loss of TRY12 million (EUR4 million), compared with a profit of TRY39 million a year earlier. The operating result was a loss of TRY113 million (EUR34 million), more than 10 times the operating loss of 2Q2015.

Revenue fell by 4.3% to TRY798 million (EUR244 million) and Pegasus' operating margin tumbled by 13.0ppts to -14.1%. Although not as low as its 1Q2016 operating margin of -24.1%, the decline in margin was heavier than 1Q's 8.2ppt drop.

See related report: Pegasus Airlines: 1Q loss grows; pricing comes under pressure from capacity growth and macro factors

Pegasus Airlines financial and operating highlights 2Q2016 and 1H2016

TRY million except where stated	2Q2015	2Q2016	Change	1H2015	1H2016	Change
Total revenue	833.9	797.7	-4.3%	1,417.1	1,488.8	5.1%
Operating costs	843.5	910.3	7.9%	1,519.5	1,768.3	16.4%
Operating profit*	-9.6	-112.6	1073.2%	-102.4	-279.5	173.0%
Operating margin %	-1.2	-14.1	-13.0ppts	-7.2	-18.8	-11.5ppts
Net profit	38.5	-12.4	-132.2%	-42.2	-203.0	381.4%
Total passengers million	5.65	5.87	3.9%	10.2	11.2	10.5%
Passenger Load Factor %	78.1	77.0	-1.1ppts	77.9	76.6	-1.3
ASK million	7,153	7,489	4.7%	12,798	14,422	12.7%
RASK kurus	11.66	10.65	-8.6%	11.07	10.32	-6.8%
CASK kurus	11.79	12.16	3.1%	11.87	12.26	3.3%
Ex-fuel CASK kurus	7.67	9.08	18.4%	7.79	9.26	18.9%

*Operating profit before Other operating income and expense
Source: CAPA - Centre for Aviation, Pegasus Airlines

1H operating margin the lowest among Europe's listed airlines so far

For 1H2016, Pegasus' operating result was a loss of TRY280 million (EUR86 million), compared with a TRY102 million loss in 1H2015. 1H revenue grew by 5% to TRY1,489 million (EUR457 million) and Pegasus' 1H margin collapsed by 11.5ppts to -18.8%.

This margin was lower even than airberlin's 1H2016 operating margin of -14.4%, making Pegasus the least profitable listed European airline group to report for the period so far.

Operating margins for listed European airline groups (% of revenue) 1H2015 and 1H2016

Note: 1H based on calendar years except SAS (six months to Mar15 and Mar-16)
Operating margin based on operating profit before exceptional items and before equity investments
Source: CAPA - Centre for Aviation, airline company reports

ASK growth of 4.7% in 2Q, slowed from 22.8% in 1Q, as geopolitical concerns hit demand

In 2Q2016, Pegasus increased its seat numbers by 5.4%, driven mainly by an 8.2% increase in scheduled seats in the domestic market, but slowed by international seat growth of 3.5%. Charter seats were cut by 47.6%.

Total ASK growth was 4.7%, a little slower than seat growth as a result of shorter average trip lengths (reflecting stronger growth on domestic routes). This was a deceleration of Pegasus' capacity growth following its 22.8% increase in 1Q2016, reflecting both capacity constraints at Istanbul Sabiha Gokcen Airport and falling demand for international travel to Turkey.

In spite of slowing capacity growth, load factor dipped by 1.0ppts to 77.0%, dragged down by a 3.8ppt slump on international flights to 69.3%. Domestic load factor managed a modest increase, by 0.7ppts to 81.9%.

Although its growth slowed considerably, Pegasus' passenger growth of 4.0% outpaced the overall Turkish market, which suffered a 7% drop in numbers in 2Q2016. Pegasus' domestic passenger numbers grew by 9.2%, compared with 5% in domestic Turkey overall.

Its international passenger numbers fell by 1.9%, compared with a 19% drop in all markets to/from Turkey. The collapse in demand on international routes reflected a series of geopolitical/terrorist events throughout 1H2016.

Such concerns have not abated following the end of the half year. The attempted coup in Turkey that took place in Jul-2016 further slowed Pegasus' traffic growth for the first month of 3Q2016, with passenger numbers increasing by only 1.3% (international down by 3.6% and domestic up by 4.7%).

Nevertheless, this was still a relatively strong performance, especially given the partial closure of Turkish airspace following the coup attempt and the 3.6% drop in passenger numbers at Sabiha Gokcen Airport overall in Jul-2016.

Pegasus' outperformance against the market highlights the attraction of its low fares, enabled by its ultra-LCC cost base.

Pegasus Airlines traffic statistics 2Q2016 vs 2Q2015

	2Q2015	2Q2016	Change
Block Hour	70,159	75,183	7.2%
Cycle	39,054	41,390	6.0%
ASK (million)	7,153	7,489	4.7%
Pax	5,649,723	5,873,734	4.0%
Total Scheduled	5,539,037	5,817,758	5.0%
Scheduled Dom	3,462,511	3,780,506	9.2%
Scheduled Int	2,076,526	2,037,252	-1.9%
Charter	110,686	55,976	-49.4%
Seats	7,237,659	7,625,478	5.4%
Total Scheduled	7,109,274	7,558,212	6.3%
Scheduled Dom	4,268,191	4,617,900	8.2%
Scheduled Int	2,841,083	2,940,312	3.5%
Charter	128,385	67,266	-47.6%
LF % (Pax/Seat)	78.1%	77.0%	-1.0ppts
Total Scheduled	77.9%	77.0%	-0.9ppts
Scheduled Dom	81.1%	81.9%	0.7ppts
Scheduled Int	73.1%	69.3%	-3.8ppts

Source: CAPA - Centre for Aviation, Pegasus Airlines

A very rare year on year revenue decline, reflecting heavy yield pressure

Pegasus' revenue fell by 4.3% in 2Q2016, in spite of the capacity increase. This was possibly the first year on year revenue decline in any quarter since its inception and certainly the first since its IPO.

Revenue from international scheduled flights plummeted by 17.6%, compared with a 3.5% increase in seat numbers. Domestic revenue grew by 5.9%, although this did not match an 8.2% capacity increase. Total scheduled flight revenue (72% of the total) fell by 8.4% and charter flight revenue (2% of the total) fell by 46.2%.

Flight revenue per passenger fell by 13.5% to TRY100.2. Its domestic yield fell by 3% to THY68.6 and its international yield, which it tracks in EUR terms, fell by 25% to EUR47.

Pegasus Airlines revenues 2Q2016 vs 2Q2015

TRY million	2Q2015	2Q2016	Change	% of 2Q2016 total
Int'l scheduled flights	379.7	313.0	-17.6%	39%
Domestic scheduled flights	244.9	259.3	5.9%	33%
Total scheduled flight revenue	624.6	572.2	-8.4%	72%
Ancillary revenue	164.8	195.0	18.3%	24%
Charter revenue	29.7	16.0	-46.2%	2%
Other revenue	14.8	14.5	-2.0%	2%
Total revenue	833.9	797.7	-4.3%	100%

Source: CAPA - Centre for Aviation, Pegasus Airlines

Ancillaries continue to perform well

Ancillary revenue continues to be a bright spot for Pegasus, with an 18.3% increase in 2Q2016, when it accounted for 24% of total revenue (up from 20% a year earlier). Ancillary revenue per passenger grew by 13.9% to TRY33.22, although much of this growth reflected currency movements.

In EUR terms, ancillary revenue per passenger was up 2.5% to EUR10.15 in 2Q2016. Its 1H2016 figure of EUR10.13 is inside its target range of EUR10-11 for FY2016.

Costs grow faster than capacity and revenue

Costs increased by 7.9% in 2Q2016, faster than the increase in capacity and contrasting sharply with the fall in revenue. Fuel costs fell by 21.9%, taking their share of total costs down to 25% from 35% a year earlier. However, ex fuel costs grew by 24.0%, including a 46.6% increase in labour costs.

Ex fuel costs were adversely affected by currency movements and also by underlying factors including airport disruption costs and an increased proportion of operating leased aircraft (44 out of 72 aircraft at end Jun-2016, versus 37 out of 65 a year earlier).

Pegasus Airlines operating costs 2Q2016 vs 2Q2015

TRY million	2Q2015	2Q2016	Change	% of 2Q2016 total
Fuel costs	294.9	230.2	-21.9%	25%
Labour costs	108.5	159.1	46.6%	17%
All other costs	440.1	521.0	18.4%	57%
Total costs	843.5	910.3	7.9%	100%

Source: CAPA - Centre for Aviation, Pegasus Airlines

A pattern of RASK growth being weaker than CASK growth

Fuel CASK benefits were more than offset by RASK decline and Pegasus' margin was further hit by ex fuel CASK growth.

According to CAPA calculations, Pegasus' RASK (total revenue per ASK) fell by 8.6% in 2Q2016. Its CASK (cost per ASK) increased at the lesser rate of 3.1% and ex fuel CASK increased by 18.4%.

Both RASK and CASK were boosted by currency movements as TRY weakened against EUR. Expressed in Pegasus' functional currency, EUR, its RASK fell by 17.7%, a very heavy fall reflecting weak international demand. Its EUR-denominated CASK was down by 7.2%, while ex fuel CASK grew by 6.6% in EUR terms.

As ever, the difference between RASK growth and CASK growth (regardless of currency) is what drives operating margin. In EUR, Pegasus' RASK has fallen more rapidly than its CASK in each of the past three quarters, in spite of falling fuel prices. RASK growth has been weaker than CASK growth in nine of the past 13 quarters.

Pegasus Airlines year on year change in EUR-denominated RASK and CASK 1Q2013 to 2Q2016

Source: CAPA - Centre for Aviation, Pegasus Airlines

2016 guidance lowered

Pegasus has revised its 2016 guidance to reflect a more negative outlook. It has lowered its ASK growth plan from a range of 18%-20% to 9%-11% (ASKs grew by 12.7% in 1H). Passenger growth is to be reduced from 13%-15% to 5%-7% (it was up 10.5% in 1H).

Whereas load factor was previously expected to be flat, Pegasus now expects a 4-6ppt decline on international routes (down 4.1ppts in 1H), compared with previous guidance of a "downside trend". Domestic load factor is still expected to be flat (up 0.3ppts in 1H).

Pegasus now expects international yield to be down by EUR9-10, whereas previously it only expected a "downside trend". Its domestic yield is now expected to fall by TRY2-3, rather than to remain flat.

Pegasus now anticipates total CASK, expressed in EUR, to fall by only 1%-2%, rather than 2%-3%. The airline has significantly cut its target EBITDAR margin range from 19%-21% to 11%-13%, much lower than its 2015 outcome of 19.5%.

Pegasus Airlines revised guidance for FY2016

Source: Pegasus Airlines

2016 operating loss now likely

Pegasus' profitability has become increasingly seasonal in recent years. In 2013, it made a small operating profit in 1H, thanks to its 2Q result. Since then, growing 1Q losses and 2Q's fall into loss have meant that 1H has now been loss-making for three successive years.

Losses in 4Q have grown, but 2H has remained profitable thanks to the strongest quarter, namely 3Q. In 2015, 3Q which generated more than twice Pegasus' annual operating profit. Although 3Q results have grown since 2013, annual operating profits have fallen as results in the weaker quarters have deteriorated.

See related report: Pegasus Airlines' waiting game. Take a margin hit now to keep market share, pending fuel price rises

In 2015, Pegasus achieved a 2H operating loss of TRY279 million, almost the same figure as its 1H operating profit this year. Given the deteriorating year on year trend of quarterly operating results, it is highly unlikely to repeat its second half performance this year. The third quarter will not be able to offset losses in the other quarters and Pegasus now looks set for an operating loss in FY2016.

Pegasus Airlines operating profit (TRY million) by quarter 1Q2013 to 2Q2016

Source: CAPA - Centre for Aviation, Pegasus Airlines

Looking further ahead, and taking a slightly more positive line, Pegasus continues to have one of the lowest levels of unit cost (CASK) in Europe. In Jul-2016, it took delivery of the first of an order of up to 100 A320neo family aircraft and this should provide further cost efficiencies.

This year, a combination of geopolitical concerns and low fuel prices have contributed to a very heavy decline in RASK, which has made profitability elusive, even for an airline with Pegasus' low CASK.

A period of slower growth seems prudent (indeed, previous CAPA analysis has suggested this), but Pegasus' low cost base should allow it to weather the storm and to return to profit when pricing pressures ease.