18-Aug-2015 3:44 PM

Pegasus Airlines: weak unit revenue drags 2Q into operating loss. Sabiha Gokcen remains competitive

Analysis

In 2Q2015, Pegasus Airlines' operating result fell into loss in what is usually a profitable quarter for the Turkish LCC. Foreign currency movements served to inflate both revenue and costs, with a net negative impact on profitability.

However, the negative result was largely driven by the weakness of unit revenue (RASK), which was dragged down both by poor yields and falling load factors. It seems that the competitive landscape at Sabiha Gokcen, Pegasus' main base, remains highly competitive thanks to Turkish Airlines' expansion and the LCCs own strong capacity growth.

If it is to meet its FY2015 profitability target, Pegasus will have to perform more strongly in 2H2015, in particular in 3Q (which typically accounts for the vast bulk of annual profit).

Summary

Pegasus Airlines reported a net profit of TRY38 million in 2Q2015, down 55.5% from the previous year.
The operating result fell from a profit of TRY81 million in 2Q2014 to a loss of TRY10 million in 2Q2015.
The drop in operating profit in 2Q offset the improvement in 1Q, resulting in a heavier loss for the first half of 2015 compared to the previous year.
Pegasus Airlines increased its ASKs by 12.3% in 2Q2015, with slightly faster growth in the domestic market than the international market.
Passenger load factor fell by 1.8ppts to 78.1% in 2Q2015, contributing to a decline in overall load factor for the first half of the year.
Pegasus Airlines' revenue increased by 5.0% in 2Q2015, but RASK (revenue per available seat kilometer) decreased by 6.6% due to weak passenger yield and falling load factor.

Pegasus' 2Q2015 operating result falls back into loss

In 2Q2015, Pegasus Airlines reported a net profit of TRY38 million, down by 55.5% from the TRY87 million result a year earlier. This year's result was boosted by foreign exchange gains on financial instruments and derivative contracts and by a positive deferred tax item, partly offset by foreign exchange losses on operating items.

The operating result (before other operating income and expense), which gives a truer indication of the underlying performance of the business, fell from a profit of TRY81 million in 2Q2014 to a loss of TRY10 million in 2Q2015. Revenue increased by 5.0% to TRY834 million and the operating margin fell by 11.4ppts to -1.2%.

The drop in operating profit in 2Q more than offset the improvement in 1Q, bringing the half year result to a heavier loss than last year. For 1H2015, revenue grew by 8.6% to TRY1,417 million and the operating loss widened more than threefold from a loss of TRY32 million to a loss of TRY102 million.

Pegasus Airlines financial and operating highlights 2Q2015 and 1H2015

TRY million except where stated	2Q2014*	2Q2015	Change	1H2014*	1H2015	Change
Total revenue	794.6	833.9	5.0%	1,305.4	1,417.1	8.6%
Operating costs	713.4	843.5	18.2%	1,337.5	1,519.5	13.6%
Operating profit**	81.2	-9.6	-111.8%	-32.1	-102.4	219.5%
Operating margin %	10.2	-1.2	-11.4ppts	-2.5	-7.2	-4.8ppts
Net profit	86.6	38.5	-55.5%	-18.0	-42.2	134.8%
Total passengers million	5.17	5.65	9.3%	9.24	10.2	10.1%
Passenger Load Factor %	79.9	78.1	-1.8ppts	79.4	77.9	-1.5ppts
ASK million	6,367	7,153	12.3%	11,173	12,798	14.5%
RASK kurus	12.48	11.66	-6.6%	11.68	11.07	-5.2%
CASK kurus	11.20	11.79	5.3%	11.97	11.87	-0.8%
Ex-fuel CASK kurus	6.60	7.67	16.1%	7.19	7.79	8.3%

2Q ASK growth of 12.4%, load factor dips

Pegasus increased its ASKs by 12.3% in 2Q2015, slower than the 17.4% growth in 1Q2015 to give an increase in 1H2015 of 14.5%. ASK growth in 2Q was slightly faster in the Turkish domestic market (13.4%) than in the international market (11.8%), reversing the pattern of 1Q, when international growth (22.7%) was stronger than domestic growth (9.7%).

Passenger load factor fell by 1.8ppts to 78.1% in 2Q, a bigger fall than 1Q's 0.9ppts decline so that 1H load factor was down by 1.4ppts to 79.4%. After healthy load factor increases from FY2011 to FY2013, followed by a modest dip in FY2014, this acceleration of the fall in load factor so far this year is a source of some concern.

Pegasus Airlines traffic statistics 1H2015 and 1H2014

Revenue up 5.0%; RASK down 6.6%

Pegasus' revenue increased by 5.0% in 2Q2015, less than the growth in ASKs. Revenue from international scheduled flights increased by 9.4%, although this was less than the increase in international ASKs, and domestic flight revenue fell by 1.8% in spite of ASK growth.

Ancillary revenue performed strongly, growing by 23.7% in 2Q, with ancillary revenue per passenger up by 13.2% to TRY29.17, or EUR9.90. For 1H2015, ancillary revenue per passenger was TRY10.04, consistent with Pegasus's target of EUR10 for FY2015 (compared with EUR9.29 in FY2014).

In 2Q2015, domestic yield (revenue per passenger) fell by 11% year on year (-8% in 1H), reflecting strong competition at Pegasus' Istanbul Sabiha Gokcen base and the partial shift of Ramadan into June in 2015 (it was mainly in July in 2014). International yield, denominated in EUR, fell by 4% (+4% in 1H).

Total revenue per ASK (RASK) fell by 6.6% year on year in 2Q, according to our calculations, mainly reflecting weak passenger yield, exacerbated by falling load factor. Nevertheless, RASK was boosted slightly by the weakening of TRY versus EUR. In EUR terms, RASK fell by 8.2%.

Pegasus Airlines revenues 2Q2015

TRY million	2Q2014	2Q2015	Change	% of 2Q2015 total
Int'l scheduled flights	347.2	379.7	9.4%	46%
Domestic scheduled flights	249.5	244.9	-1.8%	29%
Total scheduled flight revenue	596.7	624.6	4.7%	75%
Ancillary revenue	133.2	164.8	23.7%	20%
Charter revenue	49.4	29.7	-39.9%	4%
Other revenue	15.3	14.8	-3.3%	2%
Total revenue	794.6	833.9	5.0%	100%

Operating costs up 18.2%; CASK up 16.1%

Pegasus' total operating costs increased by 18.2%, faster than the growth in ASKs and revenue in 2Q2015. Fuel costs were almost at the same level as in the prior year period, in spite of the capacity increase, thanks to lower jet fuel prices, partly offset by a stronger USD versus TRY exchange rate (fuel cost per ASK fell by 10.4% in TRY terms).

Fuel accounted for 35% of total costs in 2Q2015, down from 41% a year earlier. According to CAPA calculations, Pegasus' 2Q fuel bill would have been TRY34 million higher (and its operating profit lower by the same amount) if it had paid the same fuel cost per ASK in 2Q2015 as it did in 2Q2014.

Ex fuel costs grew by 30%, much faster than ASK growth. We calculate that ex fuel cost per ASK was up by 16.1% and total cost per ASK was up by 5.3% based on reported TRY data. In Pegasus' functional currency of EUR, ex fuel CASK increased by 14.2% and CASK increased by 3.2%.

Pegasus Airlines operating costs 2Q2015

	2Q2014	2Q2015	Change	% of 2Q2015 total
Fuel costs	292.9	294.9	0.7%	35%
Labour costs	92.2	108.5	17.7%	13%
All other costs	328.3	440.1	34.1%	52%
Total costs	713.4	843.5	18.2%	100%

Currency movements: overall negative impact on operating profit

Both revenue and cost, as reported in TRY, were inflated by currency movements, 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. In 1H2015, it had 55% of costs in USD, but only 17% of revenues. Its EUR exposure is greater on the revenue side (37%) than on the cost side (23%). The negative cost impact on profit of TRY weakening versus USD was more significant than the positive revenue impact of TRY weakening versus EUR. According to Pegasus, a one cent movement in EUR/TRY and USD/TRY impacts 1H2015 EBIT by +TRY0.2 million and -TRY1.0 million respectively.

Pegasus Airlines P&L sensitivity to currency movements and fuel prices (TRY million) 1H2015

FY2015 passenger growth target trimmed

Pegasus has made some changes to its guidance and targets for FY2015 compared with those stated at the time of its 1Q2015 results announcement. It still plans ASK growth of 17%-19%, implying faster growth in 2H than the 14.5% increase in 1H.

Although this ASK growth plan is unchanged, Pegasus now expects passenger numbers to be up by 13%-15%, instead of 15%-17% previously. This follows a downgrade by aviation authority DHMI in the forecast growth in total passenger numbers in the Turkish market from 12% to 7% in 2015.

In the domestic market, the airline expects to report flat load factor and a slight yield decline, implying a better trends in 2H versus 1H in both load factor and yield. International load factor is expected to be down slightly (it fell by 2.4pts in 1H, so this fall will have to be narrower in 2H) and international yield (in EUR) are predicted to be flat in 2015 (after growing by 4% in 1H, but falling by 4% in 2Q).

Overall, this guidance on load factor and yield implies a modest underlying RASK decline in FY2015, although foreign exchange movements could lead to a more positive RASK trend in TRY terms. FY2015 CASK (in EUR) is expected to be up 2%-3%, compared with a 2% increase in 1H.

Pegasus still expects a FY2015 EBITDAR margin in the range 19% to 21% (it achieved 19.5% in 2013). Its 1H2015 EBITDAR margin fell by 1.9ppts to 8.7% in 1H2015 and the FY2015 target implies that it will need to improve on its 2H2014 EBITDAR margin of 26.1% in 2H2015.

Fierce competitive environment weighing on unit revenue

In Pegasus' functional currency, EUR, its CASK has shown year on year growth in each of the past four quarters, going back to 3Q2014. Although RASK also grew in each quarter from 3Q2014 to 1Q2015, it fell in 2Q21015 while CASK continued to increase.

The spread between RASK growth and CASK growth fell negative again in 2Q2015 (ie RASK growth was weaker than CASK growth), after turning positive in 1Q2015.

Pegasus Airlines year on year change in EUR-denominated RASK and CASK 1Q2013 to 2Q2015

With CASK expected to grow in 2H at a similar rate to 1H, the key to FY2015 profitability will likely be the performance of Pegasus' RASK. Its weakness in 2Q2015 suggests that the competitive environment remains fierce.