14-Nov-2014 3:40 PM

Pegasus Airlines: one of Europe's most profitable airlines returns to improving profitability trend

Analysis

After four successive quarters of year on year declines in its underlying operating result, Pegasus Airlines reported an increase in 3Q2014. Its operating margin was at the same level as 3Q2013, after falling in 1H, and second in Europe only to Ryanair (of those to report thus far).

As always, Pegasus' results are complicated by foreign exchange, especially as Turkey's currency has weakened against EUR and USD. Expressed in its functional currency of EUR, rather than its reporting currency of TRY, Pegasus' CASK (cost per available seat km) edged up slightly in 3Q, reversing the decline of 1H. Fortunately, RASK (revenue per available seat km) also increased at a similar rate, ending a four quarter falling trend. This was helped by a relative slowing of its capacity growth in addition to less aggressive pricing by Turkish Airlines at Sabiha Gökçen.

Pegasus has reiterated its FY2014 guidance, although there now seems to be scope for it to do better. Our suggestion after 2Q results, that Pegasus may have turned a corner and be ready to leave the path of deteriorating margins, seems to be gaining credibility.

Summary

Pegasus Airlines reported an increase in its underlying operating result in 3Q2014, after four consecutive quarters of decline.
The operating margin of Pegasus Airlines remained stable at 26.4% in 3Q2014, second only to Ryanair among European airlines.
Pegasus Airlines' revenue per available seat km (RASK) increased in 3Q2014, ending a four-quarter falling trend.
The airline's net profit more than doubled in 3Q2014, boosted by favorable exchange rate movements and lower net financial charges.
Pegasus Airlines' capacity growth slowed down in 3Q2014, with a load factor of 82.7%.
Turkish Airlines' aggressive pricing at Istanbul Sabiha Gökçen eased, benefiting Pegasus Airlines.

Pegasus Airlines' operating profit up 3% in 3Q2014

In 3Q2014, Pegasus more than doubled its net profit to TRY252 million (EUR88 million) from TRY115 million in the same period a year earlier, boosted by favourable exchange rate movements and lower net financial charges. The improvement in the underlying profitability was less pronounced. Operating profit (before other operating income/expenses) grew by 33% to TRY293 million (EUR102 million).

Revenue growth was also 3% and the operating margin was stable at 26.4%. The gain in underlying operating profit in 3Q2014 was not enough to offset the deterioration in the 1H2014 result and 9M2014 operating profit fell 17% year on year on TRY261 million (EUR89 million). Its 9M margin fell by 6.5 ppts to 10.8%.

See related reports:

Pegasus Airlines financial and operating highlights 3Q2014 and 9M2014

TRY million except where stated	3Q2013	3Q2014	Change	9M2013	9M2014	Change
Total revenue	835	1108.6	32.8%	1,824.3	2,419.8	32.6%
Operating costs	613.9	815.5	32.8%	1,508.1	2,158.7	43.1%
Operating profit*	221.2	293.1	32.5%	316.2	261.1	-17.4%
Operating margin %	26.5	26.4	-0.0 ppts	17.3	10.8	-6.5 ppts
Net profit	115.3	252.0	118.6%	159.4	234.1	46.8%
Pegasus operation revenue	835.1	1,108.7	32.8%	1,815.3	2,419.8	33.3%
Pegasus operation costs	613.9	815.5	32.8%	1,496.4	2,158.7	44.3%
Operating profit Pegasus operation*	221.2	293.2	32.5%	318.9	261.1	-18.2%
Operating margin Pegasus operation %	26.5	26.4	-0.0 ppts	17.6	10.8	-6.8 ppts
Total passengers million	5.03	5.78	14.9%	12.58	15.02	19.4%
Passenger Load Factor %	82.8	82.7	-0.1	80.6	80.6	0
ASK million	6,120	7,224	18.0%	15,077	18,397	22.0%
RASK kurus	13.65	15.35	12.5%	12.04	13.15	9.2%
CASK kurus	10.03	11.29	12.5%	9.93	11.73	18.2%
EX-fuel CASK kurus	5.62	6.40	13.9%	5.72	6.91	20.9%

Pegasus' 3Q and 9M2014 operating margins place it above the Big Three European legacy groups, its local rival Turkish Airlines and Aer Lingus. Among the major European airlines that have reported for the period, only Ryanair had higher margins than Pegasus.

Operating margins for Ryanair*, Aer Lingus, IAG, Lufthansa and Air France-KLM 3Q2014 and 9M2014

ASKs were up 18%

Pegasus increased total ASKs by 18% in 3Q2014, with load factor just below flat at 82.7% (-0.1ppts). This capacity growth was slower than the 24.8% rate in 1H2014 and 9M ASK growth was 22.0%.

Pegasus' 9M load factor of 80.6%, flat on last year, is closer to the levels recorded by full service carriers than it is to the higher levels enjoyed by Europe's main LCCs. Pegasus' load factor performance has been slightly better on its domestic network (where capacity growth has also been a little slower) than on its international network.

Pegasus Airlines traffic statistics 3Q2014 and 9M2014

Revenue rose 33%

Pegasus' 3Q revenue growth of 33%, faster than ASK growth, was mainly driven by a 32% increase in scheduled flight revenues, boosted by a 55% increase in ancillary revenues, but slowed by growth of only 14% in charter revenues. Ancillary revenue per passenger increase by 35% to TRY26, or in EUR terms, by 23% to EUR9.

Scheduled revenues were propelled largely by international flights, where revenue growth was 37%. This international revenue growth compares favourably with international ASK growth of 18.5%, although it was helped by the strengthening of EUR against TRY. In EUR terms, Pegasus' international network still generated unit revenue growth of around 7%.

Domestic flight revenues grew by 24%, compared with ASK growth of 17.1%. Previous price weakness at Sabiha Gökçen (SAW), cased by Turkish Airlines' rapid expansion and introductory pricing at the airport, has eased following the competitor's return to more normal pricing.

According to our calculations, total revenue per ASK (RASK) grew by 12.5% year on year, boosted by a fall in the value of TRY against international currencies. Converting to EUR at average exchange rates for both 3Q2014 and 3Q2013, the increase in RASK was 2.3%.

Pegasus Airlines revenues 3Q2014

TRY million	3Q2013	3Q2014	Change	% of 3Q2014 total
Int'l scheduled flights	403.2	553.4	37.3%	50%
Domestic scheduled flights	248.2	307.8	24.0%	28%
Total scheduled flight revenue	651.4	861.2	32.2%	78%
Ancillary revenue	96.9	149.9	54.7%	14%
Charter revenue	71.4	81.3	13.9%	7%
Other revenue	15.4	16.3	5.8%	1%
Pegasus operation revenue	835.1	1108.7	32.8%	100%
AirBerlin Turkey operation revenue	0	0		0
Total revenue	835.1	1108.7	32.8%	100%

THY price pressure at Istanbul Sabiha Gökçen is easing

Turkish Airlines entered SAW in order to increase its growth options as its main hub at Istanbul Ataturk became more congested. Even after the opening of the planned new Istanbul airport, Turkish is likely to maintain a significant presence at SAW.

Indeed, THY CEO Temel Kotil recently said "We will establish a permanent fleet in the Sabiha Gökçen Airport of Istanbul. We'll be transferring our 100 airplanes to the Sabiha Gökçen from our main base in the third airport, which will still have 300 THY airplanes" (Hurriyet Daily News, 11-Nov-2014).

Pegasus' lower cost structure and different route network focus should allow Turkey's two largest carriers to co-exist at SAW. As Pegasus CEO Sertac Haybat told analysts on a conference call to discuss the 3Q results, "whatever Turkish Airlines' presence is in Sabiha Gökçen, the important thing is as long as we keep the CASK difference, we do not have anything to worry about."

Costs up 33%, same as revenue

Operating costs grew by 33%, the same rate as revenue growth, with fuel costs up 31% and non-fuel costs up 34% in 3Q2014. We calculate that CASK grew by 12.5% and ex fuel CASK by 13.9%. Weakness of TRY against EUR and USD increased the rate of CASK growth. In EUR terms, unit cost growth was more modest, with CASK up 2.4% ex fuel CASK up 3.6%.

Pegasus Airlines operating costs 3Q2014

	3Q2013	3Q2014	Change
Fuel costs	270.1	353.4	30.8%
Labour costs	72.9	98.2	34.7%
All other costs	270.9	363.9	34.3%
Pegasus operation costs	613.9	815.5	32.8%
AirBerlin Turkey operation costs	-	-	-
Total costs	613.9	815.5	32.8%

FY2014 guidance looks conservative

The 3Q2014 operating result (before other operating income/expenses) was the first quarter in four to be higher than that reported for the same period a year earlier albeit at the same margin. This is because it was also the first quarter in this time when RASK growth matched CASK growth.

Pegasus Airlines year on year change in EUR-denominated RASK and CASK 1Q2013 to 3Q2014

Pegasus has modestly trimmed its FY2014 target for growth in passengers (and ASKs) from 20% to 18% but is still targeting an EBITDAR margin in the range 17% to 19% (versus 22% in 2013). This guidance implies year on year growth in EBITDAR in absolute terms (albeit at a lower margin) in FY2014 and in 4Q2014. After falling in 1H2014, EBITDAR increased by 9% in 9M2014, although the 9M margin was down 5ppts to 21.6%, and should be higher for the full year.

However, disproportionate increases in depreciation and operating lease rentals mean that the 2014 operating profit will likely be lower than in 2013. The EBITDAR guidance also suggests that the 4Q2014 operating loss may be wider than in 4Q2013 (before other operating income/expenses). The latter point would mean that 3Q's out-performance of RASK against CASK growth would again be reversed in 4Q.

Pegasus is one of only three ultra low cost airlines in Europe and the only one with a significant presence in Turkey. The more stable yield outlook and likely benefit to the cost base from the fall in oil prices, should enable Pegasus to improve on its FY2014 target.