14-Nov-2013 6:48 PM

Pegasus: even the best business models hit turbulence as 3Q2013 net result falls 27%

Analysis

Pegasus is demonstrating strong profitability following its IPO in Apr-2013, since when its share price has doubled. It is now among Europe's more profitable airlines and one of its lowest-cost practitioners. In 3Q2013, the underlying operating result of the core operation increased by 18% compared with last year and this result has more than doubled over the first nine months of the year.

However, net profit fell in 3Q2013 as the weakening Turkish lira led to adverse foreign exchange impacts on the profit and loss statement. In addition, the operating margin declined year-on-year in the quarter as RASK growth was outpaced by CASK growth. It is not time to take any drastic evasive action, but it seems even the more financially robust airlines cannot avoid some turbulence at times.

Summary

Pegasus Airlines has demonstrated strong profitability since its IPO in 2013, with its share price doubling and becoming one of Europe's most profitable and low-cost airlines.
Net profit fell in 3Q2013 due to adverse foreign exchange impacts, but the underlying operating result increased by 18% compared to the previous year.
Pegasus Airlines experienced strong capacity growth of over 20% in 3Q2013, with a slight increase in domestic market growth and a slight decrease in international markets.
Revenues grew faster than capacity, driven by an increase in scheduled flight revenues, ancillary revenue, and charter revenue.
Total operating costs increased by almost 30% in 3Q2013, outpacing revenue growth rates and leading to a decline in operating margins.
Pegasus Airlines expects continued pressure on yields in European markets but aims to offset this with increased load factors and cost control measures.

Net profit falls in 3Q, but operating result up 18% for core operation

In 3Q2013, Pegasus Airlines saw a 27% fall in its net profit to TRY115 million (EUR41.57 million). However, financial expenses were burdened by a foreign exchange loss of TRY40 million (EUR14.45 million), whereas they were lightened last year by a foreign exchange gain on TRY29 million (EUR10.48 million). This is a non-cash expense related to the translation of loans in foreign currency back into Turkish lira. Without this adverse swing of TRY69 million (EUR24.94 million), net profit would have been up year-on-year.

The underlying performance is better reflected in the operating profit (before other operating income and expenses). This grew by almost 13% to TRY221 million (EUR79.89 million), although the operating margin fell 2.8 ppts to 26.4%. Pegasus ceased its airberlin Turkey charter operations in 1Q2013 and the like-for-like operating result (excluding airberlin Turkey from last year) grew by 18% in 3Q2013, with margin falling 2.6 ppts. Revenues grew by 25%, or 30% excluding airberlin from last year.

For the first nine months of 2013, the core Pegasus operation grew its revenues by 33% and more than doubled its operating result to TRY319 million (EUR115.28 million) (before other operating income and expenses). Net profit for the group increased by 83% to TRY162 million (EUR58.54 million) in the first nine months. The 3Q result was adversely affected by the weakening of the TRY against USD and EUR, since it has more costs than revenues in international currencies.

Pegasus Airlines financial and operating highlights: 3Q2013

TRY million except where stated	3Q2012	3Q2013	Change
Total revenue	670.1	836.7	24.9%
Operating costs	(474.0)	(615.5)	29.8%
Operating profit*	196.1	221.2	12.8%
Operating margin %	29.3%	26.4%	-2.8 ppts
Net profit	157.9	114.7	-27.4%
Pegasus operation revenue	644.8	836.7	29.8%
Pegasus operation costs	(457.4)	(615.5)	34.6%
Operating profit Pegasus operation*	187.4	221.2	18.1%
Operating margin Pegasus operation %	29.1%	26.4%	-2.6 ppts
Total passengers million	4.1	5.0	22.1%
Passenger Load Factor %	81.9%	82.8%	+0.9 ppts
ASK million	5,097	6,119	20.1%
RASK kurus	12.65	13.67	8.1%
CASK kurus	8.97	10.06	12.1%
EX-fuel CASK kurus	4.77	5.64	18.2%

Strong capacity growth continues at more than 20%

In 3Q2013, Pegasus increased its ASKs by 20.1%, with a slightly higher rate of growth in the domestic market and slightly lower in international markets. The growth in the numbers of seats was a little faster at 20.8%, suggesting a modest decrease in average sector length. Passenger load factor (passengers/seats) grew by 0.9 ppts to reach 82.8% and passenger numbers were up 22.1%. Daily aircraft utilisation reach 14 block hours, compared with 13.3 block hours in 3Q2012.

Over the first nine months of 2013, ASK growth was 21.6%, but it was a little slower on the domestic market and faster in international markets. Load factor gained 1.7 ppts to 80.6% in the first nine months.

Pegasus Airlines traffic data: 3Q2013

Millions except where stated	3Q2012	3Q2013	Change
PAX	4.12	5.03	*22.1%*
Dom	2.31	2.88	24.4%
Int'l	1.81	2.16	19.1%
ASK	5,097	6,119	*20.1%*
Dom	1,596	1,945	21.9%
Int'l	3,501	4,174	19.2%
RPK	4,115	4,995	*21.4%*
Dom	1319	1619	22.7%
Int'l	2796	3376	20.8%
Load Factor %	81.9%	82.8%	0.9 ppts
Dom	82.7%	83.3%	0.6 ppts
Int'l	79.9%	80.9%	1.0 ppts
Total Seats	5.03	6.08	*20.8%*
Dom	2.80	3.45	23.5%
Int'l	2.24	2.62	17.4%

Revenues grow faster than capacity, boosted by ancillaries

The 30% increase in core Pegasus revenues was faster than the growth in ASKs in 3Q. This reflected an increase in scheduled flight revenues (78% of the total) by nearly one quarter, boosted by a 44% increase in ancillary revenue and a 46% increase in charter revenue.

Pegasus Airlines revenues: 3Q2013 vs 3Q2012

TRY	3Q2012	3Q2013	change	% of 3Q2013 total
Scheduled flight revenue	523,781,411	652,957,702	24.7%	78%
Ancillary revenue	67,319,202	96,910,849	44.0%	12%
Charter revenue	48,724,748	71,444,826	46.6%	9%
Other revenue	4,971,858	15,370,621	209.2%	2%
Pegasus operation revenue	644,797,219	836,683,998	*29.8%*	100%
Airberlin Turkey operation revenue	25,328,377	0	-100.0%	0%
Total revenue	670,125,596	836,683,998	*24.9%*	100%

Scheduled flight revenue growth in 3Q2013 was 23% in Turkey and almost 26% in international markets. Although revenue growth in scheduled international flights to Europe was only 15%, revenues to other international markets more than doubled. This rapid growth outside Europe reflects the resumption of Pegasus' services to Doha and Dubai and a doubling of its capacity to Tel Aviv.

Ancillary revenue per passenger grew by 18% to TRY19.3 (EUR6.97), mainly as a result of increased penetration of existing ancillary products and services.

Pegasus Airlines ancillary revenues (TRY million) and ancillary revenue per passenger (TRY)

RASK increases

Total revenue per ASK increased by 8.1% in the quarter. Scheduled RASK increased by 1% in domestic operations to 12.77 kurus and scheduled international RASK increased by 6% to 11.21 kurus 3Q2012 in spite of strong capacity growth and yield pressure in European markets.

Pegasus Airlines scheduled flight revenues by region: 3Q2013 vs 3Q2012

Region	3Q 12	3Q 13	change	% of 3Q2013 total
Turkey	201,569,097	248,436,099	23.3%	38%
Europe	283,735,188	325,254,909	14.6%	50%
Other	38,477,126	79,266,694	106.0%	12%
Total scheduled revenue	523,781,411	652,957,702	*24.7%*	100%

Costs grow faster than revenues

Total operating costs for the group increased by almost 30% in 3Q2013 and by 35% on a like-for-like basis excluding the airberlin Turkey costs from last year's figures. Both of these figures outpaced the respective revenue growth rates (which is why operating margins declined) and the increase in ASKs.

Fuel costs, which accounted for 44% of the total, grew by 26%, slower than total costs, but faster than ASK growth. Labour costs increased by 45% and all other costs by 41%.

Pegasus Airlines operating costs: 3Q2013 vs 3Q2012

TRY million	3Q2012	3Q2013	change	% of 3Q2013 total
Fuel costs	-214	-270	26.2%	44%
Labour costs	-50	-73	44.7%	12%
All other costs	-193	-273	41.2%	44%
Pegasus operation costs	-457	-615	34.6%	100%
Airberlin Turkey operation costs	-17	0	-100.0%	0%
Total costs	-474	-615	29.8%	100%

CASK (and RASK) inflated by currency movements

Total unit cost (cost per ASK, CASK) increased by 12.1% in the quarter, while ex fuel CASK grew by 18.2%.

Increased unit costs ex fuel were driven by the non airline consolidated subsidiary Izmirliler Otelcilik (which does not generate ASK); timing differences in some maintenance expenses accelerated due to high aircraft utilisation; and the new ramp contract and self traffic handling at Sabiha Gökçen Airport (commenced Jun-2013). It will be important that Pegasus can demonstrate in the future that these effects are only temporary.

Unit costs, as reported in TRY, were also adversely affected by the fall in value of the Turkish currency compared with the same period a year earlier. Translated into EUR, Pegasus' CASK fell by 3.2% and its ex fuel CASK was up by 2.4%. It is also worth noting that, while currency movements inflated its reported costs, they also boosted reported revenues. RASK translated into EUR decreased year-on-year.

Pegasus Airlines unit costs, CASK, in EUR cent and TRY kurus: 3Q2013 vs 3Q2012

	3Q2012	3Q2013	change
CASK EUR cent	3.98	3.85	-3.2%
CASK kurus	8.97	10.06	12.1%
Ex-fuel CASK EUR cent	2.11	2.16	2.4%
Ex-fuel CASK kurus	4.77	5.64	18.2%

2013 outlook unchanged, but European yields expected to be weak

For 2013, Pegasus continues to target passenger growth of around 15% and to grow ASK capacity at a rate of 12% to 16% per annum over the next three years. It sees utilisation rates for 2013 at a similar level to 2012, although the first nine months saw a 7.6% increase in block hours per day. It expects daily utilisation to increase in the future as more night flights are introduced and the network grows.

Pegasus says that forward bookings are in line with its budget into 4Q2013. It will continue to focus on enhancing its network in the north, south and east of Turkey and to maintain cost control and improved cost efficiencies. It warns of continued pressure on yields in European markets, although it expects these partially to be offset by increased load factors.

Pegasus route network

Pegasus continues to aim for a load factor of more than 80% in the short to mid term (it was 78.2% in FY2012). In terms of costs, it anticipates stable CASK in the near term, but its Continuous Improvement Team (CIT) is pursuing further cost reduction initiatives and it plans to reduce CASK beyond the near term. One area with potential to deliver lower costs is Pegasus' distribution channels. It currently makes 46% of its sales on the internet (first nine months of 2013, up from 41% for the same period last year) and aims to grow this channel, which is the most cost effective means of distribution.

Internet sales as a percentage of total sales

Strong financial performance in 2013, but no room for complacency

Pegasus' financial performance so far in 2013, the year of its initial public offering, has been impressive. In the first nine months of the year, it grew passenger numbers by 22%, revenues by 24% and net profit by 83%. Its operating margin improved by 7.4 ppts to reach 17.3% (operating result before other operating income and expenses divided by revenues) as RASK increased by 9% and CASK by only 1%.

However the most recent quarter demonstrates that Pegasus will not always have everything its own way. Operating margin fell in 3Q2013, resulting from quarterly CASK increasing year-on-year and outpacing RASK growth for the first time this year. Moreover, net profit fell versus last year in 3Q, albeit due to foreign exchange rather than operational headwinds. Pegasus remains one of Europe's genuine ultra-LCCs, but this set of quarterly results is a reminder that it cannot afford to be complacent.

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