19-Mar-2013 3:34 PM

Turkish Airlines' 2012 operating profit almost triples; 2013 more doubtful, with 20% seat growth

Analysis

In 2012, Turkish Airlines saw its operating profit grow almost threefold, with revenues up 26% on passenger capacity growth of 18%. It has the youngest fleet of any significant network carrier in Europe and its 7.0% operating margin puts it behind only Ryanair and easyJet. This financial success is built on one of Europe's most efficient cost structures and a very productive work force. THY's fleet of 211 aircraft will be expanded by the recently announced order for 117 Airbus narrowbodies to add to existing orders for narrow and widebodies from both Boeing and Airbus.

In 2013, Turkish Airlines plans a further 20% capacity increase in pursuit of its expansion strategy based on increasing transfer traffic and is seeing particularly strong growth on routes to Latin American and Africa this year. It does not expect a unit revenue increase, so CEO Temel Kotil will need to engineer a fall in unit costs if profits are to continue to climb. This will not be easy, given likely fuel cost increases and that 2012 was the only year to see a fall in ex fuel unit costs since 2007.

Summary

Turkish Airlines reported a significant increase in operating profit in 2012, almost tripling from the previous year.
The airline has one of the youngest fleets in Europe and is known for its efficient cost structure and productive workforce.
Turkish Airlines plans to further increase capacity by 20% in 2013, focusing on expanding transfer traffic and targeting growth in Latin America and Africa.
The airline does not expect an increase in unit revenue, so CEO Temel Kotil will need to reduce unit costs to sustain profitability.
Turkish Airlines has a strong focus on international transfer traffic, which accounted for 42% of total passengers in 2012.
The airline has a fleet expansion plan in place, with orders for 117 Airbus narrowbodies to be delivered by 2020, in addition to existing orders from Boeing and Airbus.

Turkish Airlines' operating profit almost tripled in 2012 after falling in 2010 and 2011

Turkish Airlines reported an operating profit of TRY1,048 million in 2012, up from TRY359 million in 2011. The net profit figure of TRY1,113 million compares with just TRY19 million in 2011.

Turkish Airlines financial highlights: 2012

TRY million except where stated	2011	2012	Change
Revenue	11,813	14,909	26.2%
Operating profit	359	1048	192.0%
Operating margin %	3.0	7.0	4.0ppts
Net profit	19	1,113	5918.4%
Cash	1,683	1,833	8.9%
Gross debt	7,913	8,667	9.5%
Net debt	6,230	6,835	9.7%
Equity	4,499	5,405	20.1%
ASK (millions)	81,193	96,124	18.4%
RPK (millions)	58,934	74,410	26.3%
Passenger load factor %	72.6	77.4	4.8ppts

RASK (TRY Kr)	12.57	13.59	8.1%
CASK (TRY Kr)	14.11	14.42	2.2%
CASK ex fuel (TRY Kr)	9.18	9.05	-1.4%

Revenues have been on a strong upward curve for a number of years, but profits had been on a downward trend since the 2009 operating profit peak before 2012 saw a recovery in both operating profit and net profit to record levels.

Turkish Airlines revenues, net profit and operating profit (EUR million): 2003 to 2012

THY is now one of Europe's most profitable airlines

Margins have varied significantly since it embarked on its growth strategy in 2006, between 2% in 2006 and 12% in 2008, but, with a 2012 operating margin of 7.0%, Turkish Airlines is now one of Europe's most profitable carriers, behind only Ryanair and easyJet.

European airlines operating margins (% of revenues): 2012*

Debt levels back under control

Debt levels increased sharply after 2009 as Turkish Airlines rapidly grew its fleet in the face of falling profits, but the increase in debt in 2012 was relatively modest. Its net debt of TRY6,835 million at the end of the year was 126% of its book equity value, down from 138% for 2011.

Adding capitalised operating leases at eight times annual payments, the adjusted net debt figure of TRY9,338 million was 173% of equity, down from 209% in 2011. These gearing levels are quite high compared with the fairly recent past (in 2009, gearing was 50% and adjusted gearing 114%), but are coming down again.

Strong traffic growth is driven by international transfer traffic, now 42% of total

Turkish Airlines is sometimes referred to as the fourth Gulf carrier, as it aggressively empowers its hub expansion. It has grown its capacity (ASK) by an average annual rate of 18% since 2005, with passenger traffic (RPK) growing at an average of 20% p.a.

In 2012, Turkish Airlines' transfer passenger numbers grew by 30% to reach 16.5 million, 42% of the total. International to international transfer passengers grew by 44% to reach 23% of the total number of passengers. This reflects the carrier's strategy to use its Istanbul hub to tap into east-west global traffic flows to connect its narrowbody catchment area of Europe, the Middle East and North Africa with the Americas and Asia, in addition to offering connections to passengers flying between the Americas and Asia.

Turkish Airlines development of capacity (ASK, million), traffic (RPK, million) and load factor (%): 2005-2012

Turkish Airlines international to international transfer passengers (000): 2005 to 2012

North America and Africa saw fastest growth in 2012

Traffic growth (RPK) of 28% in 2012 was especially driven by international routes, as domestic growth was only 10.8%. On the international network, THY saw an increase of 49% to North America, 48% to Africa, 31% to the Middle East and 28% to Europe.

Load factor, while higher in 2012 than in 2005, has not shown such a consistent upward curve over recent years, probably a result of the high number of new routes. Nevertheless, load factor grew by an impressive 4.8ppt in 2012, a significant factor in the improved profitability of the group. Load factor gains were particularly strong on routes to the Far East and the Americas.

Turkish Airlines scheduled passenger traffic by region: 2012

Turkish Airlines' transfer strategy has fuelled the company's growth in recent years, which has also been assisted by the faster growing Turkish economy relative to the rest of Europe. From 2006 to 2012, THY more than doubled its share of AEA scheduled passengers.

In its recent medium term traffic forecasts, Eurocontrol forecast that Turkey will be the fastest growing market in Europe for flights to 2019, with average annual growth of 7.0% p.a., compared with 2.3% for Europe as a whole.

Turkish Airlines market share of AEA airlines scheduled traffic: 2006 to 2012

Passenger revenues were up 28% in 2012

Group revenues grew by 26% in 2012 to TRY14.9 billion, driven by a 28% increase in scheduled passenger revenues. This, in turn, was driven by an 18% increase in capacity and an 8% increase in unit revenues (RASK).

Traffic revenue growth was particularly strong on routes to Africa (up 51%), the Americas (up 48%) and the Far East (up 32%). Europe (excluding domestic Turkey), the carrier's biggest region accounting for one third of traffic revenues, saw revenue growth of almost 24%. The domestic segment saw the slowest growth, at 'only' 16%.

Turkish Airlines revenues (TRY million): 2011 and 2012

	2011	2012	change	% of 2012 revenue
Passenger revenue	10,208	13,062	28.0%	88%
Cargo revenue	966	1,207	24.9%	8%
Unscheduled flight revenue	139	121	-12.8%	1%
Other revenue	500	519	3.8%	3%
Total Revenue	11,813	14,909	*26.2%*	*100%*

Turkish Airlines traffic revenues by region (TRY million): 2011 and 2012

	2011	2012	Change	% of 2012 revenue
Europe	3,823	4,723	23.5%	33%
Far East	2,412	3,182	31.9%	22%
Middle East	1,530	1,855	21.2%	13%
America	953	1,413	48.3%	10%
Africa	708	1,070	51.2%	8%
Total international	9,426	12,243	*29.9%*	86%
Domestic	1,748	2,026	15.9%	14%
Total scheduled flight revenue	11,174	14,269	*27.7%*	100%

Costs grew more slowly than revenues, in spite of fuel, 37% of total

Turkish Airlines' operating costs grew by 21% in 2012, slower than revenue growth, but a little faster than capacity growth.

Fuel costs, the biggest category at 37% of the total, grew by 29%. Sales and marketing costs were up almost 31% and this sharp increase may be an inevitable feature of THY's ambitious growth involving new routes and new destinations as it seeks to build a global brand image and presence. Other cost categories performed well and total ex fuel costs grew by just under 17%, well below capacity and revenue growth.

Turkish Airlines operating costs (TRY million): 2011 and 2012

	2011	2012	Change	% of 2012 costs
Fuel cost	3,999	5,159	29.0%	37%
Total labour cost	2,237	2,470	10.4%	18%
Landing & navigation fees	888	1,055	18.8%	8%
Sales & marketing costs	736	963	30.7%	7%
Aircraft lease costs	397	313	-21.1%	2%
Depreciation	765	983	28.6%	7%
Other operating costs	2,433	2,918	19.9%	21%
Total operating costs	11,454	13,861	*21.0%*	100%

Labour productivity, already strong, improves further

Turkish Airlines achieved significant growth in capacity and traffic in 2012 with a virtually stable headcount. Labour costs increased by 10%, all driven by increased employee costs per employee. Making the assumption that total capacity, measured in ATKs grew at the same 18.4% rate at which ASKs grew (the company has not yet published total ATK figure for 2012), then labour productivity also grew by 18.4%.

Factoring in the increased pay rates, employee costs per ATK were down by 6.7%, a strong result on a measure where it leads all European airlines with the exception of Vueling and Ryanair.

Moreover, revenues per employee were up by an impressive 26%.

Turkish Airlines group labour productivity measures: 2011 and 2012

	2011	2012	Change
Number of personnel	17,876	17,879	0.0%
Total labour cost TRY million	2,237	2,470	10.4%
Employee cost per employee (TRY)	125,123	138,145	10.4%
ATK per employee	667	790	18.4%
Employee costs per ATK (TRY)	0.19	0.17	-6.7%
Revenue per employee TRY	660,802	833,883	26.2%

European airlines employee cost per ATK (EUR cent): 2012*

Fleet expansion further boosted with large Airbus order for 117 narrow bodies

Turkish Airlines currently has a fleet of 211 aircraft, with an average age of 6.6 years.

By the end of 2020 it plans to have 375 aircraft, with an average age of five years.

On 15-Mar-2013 Turkish announced an Airbus order for 25 A321, four A320neo, 53 A321neo and options for 35 additional A321neo. Of the total of 117 aircraft in this recent Airbus order, 13 are to be delivered in 2015, 14 in 2016, six in 2017, 27 in 2018, 25 in 2019 and 32 in 2020.

The company already had outstanding orders at the end of 2012 for nine A321, 20 A330-300, two A330-200F, six 737-900, 16 737-800 and 20 777-3ER for delivery between 2013 and 2017.

Turkish Airlines fleet at 18-Mar-2013

Type	Number
A330-200	8
A330-300	10
A340-300	7
B777-3ER	12
Wide Body	37
B737-900ER	9
B737-800	63
B737-700	14
B737-400	3
A320-200	28
A321-200	34
A319-100	14
Narrow body	165
A310-300	4
A330-200F	5
Cargo	9
TOTAL	211

Turkish Airlines deliveries 2013 to 2020

Turkish Airlines total fleet development: 2003 to 2012 and plan for 2020

2013 to see further strong capacity growth, but no RASK growth

For 2012, Turkish Airlines targets a further 20% increase in capacity (ASK) and expects passenger numbers to grow by 18% to 46 million, with load factor up another 1.4ppt to 78.8% (this would bring load factor very close to the AEA 2012 average of 79.1%).

For the first two months of 2013, it has reported ASK growth of 22.6% and load factor up 4.7ppt to 76.5%. The strongest growth has been to Africa and South America so far this year.

While it has not set a 2013 profit target, it budgets in dollar terms for a 17% increase in revenues from USD8.3 billion in 2012 to USD9.7 billion in 2013 and expects the fuel bill to increase from USD2.9 billion to USD3.7 billion (up 28%). Allowing for some further depreciation of the Turkish lira, this revenue outlook implies that RASK will be flat to slightly down and yield down by a little more in 2013. The anticipated fuel cost increase suggests an increase in fuel costs per ASK of around 8%.

New routes focus on Latin America, Africa and Europe

THY will continue to open new routes in 2013, pursuing its global transfer strategy. In percentage terms, the highest growth will be seen in Latin America, where it had only two routes (Buenos Aires and Sao Paulo) at the end of 2012.

In 2013, it will add Bogota, Caracas, Havana and Mexico City. Africa is also seeing significant growth, with 11 new destinations to add to the 33 existing cities, and 13 new destinations are being added to the existing 84 in Europe.

Turkish Airlines destinations at Dec-2012 and planned new destinations for 2013

CASK ex fuel fell in 2012, but track record is patchy

In the years of improving profits from 2006 to 2008, Turkish Airlines saw a steep upward movement in RASK while CASK rose less steeply. Ex fuel CASK stayed flat over this period, but then rose steadily from 2008 to 2011 before dipping slightly in 2012. The fall in RASK in 2009 came when capacity grew by 22% and the world fell into a recession. CASK also fell in 2009 and so operating profit held steady, but this fall in RASK is a signal that a high growth strategy can run into trouble when severe economic weakness hits. The fall in operating profit between 2009 and 2011 was the result of CASK rising more rapidly than RASK. Rising fuel costs contributed to this CASK growth, but ex fuel CASK also went up.

The improved control over ex fuel CASK and continued RASK growth led to higher profits again in 2012. If the company is to see a further increase in profits in 2013, it will require another fall in ex fuel unit costs, assuming that THY's budgeted increase in fuel costs per ASK and slight fall in RASK prove accurate. Its track record of recent years, when it has done well merely to keep ex fuel RASK stable, suggests that cutting it will be a challenge.

Turkish Airlines - index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in 2009)

THY has an efficient cost base and needs to keep it that way

The following chart compares THY's unit costs (CASK) and average sector length with those of a number of other European competitor airlines. It highlights the very cost efficient nature of Turkish Airlines, which has the lowest unit cost among European network carriers. As noted above, it has very good labour productivity and this goes some way to explaining its cost competitiveness.

Nevertheless, cost efficiency against European carriers is not the whole picture. As THY continues to grow on routes into developing regions such as Latin America, Africa and Asia, its competition is increasingly local carriers in those regions and the Gulf carriers.

Unit costs (cost per available seat kilometre) and average sector length for selected European legacy and low-cost carriers 2012*

As the company continues to follow its ambitious fleet expansion programme and to add capacity, it should be well placed to maintain this low unit cost structure. However, as noted above, Turkish generally needs to lower its unit costs in order to increase profits and it also faces a challenge in maintaining a positive RASK trend in times of economic weakness.

Maintaining RASK growth is also challenging when pursuing high growth based on transfer traffic, which tends to be lower yield than point-to-point traffic, particularly when faced with strong competition from transfer carriers based in the Gulf.