GENEL-PUBLIC

March 8, 2018 Equity Research Aviation

Company update Europeans are back

 Strong demand continue to support industry. Turkish Airlines recorded 15.5% YoY O&D pax growth, resulting in overall 8.4% BUY YoY international pax growth in 2017. In the same year, although foreign arrivals to recovered much by 27.8% YoY almost in Share price: TL17.37 all regions, European arrivals stayed flattish in 2017. Our conversations with Association of Turkish Travel Agencies claimed Target price: TL21.60 that summer bookings from Western has jumped much by 60% YoY for 2018. Furthermore, summer bookings from domestic Expected Events tourist figures jumped to 6 million versus 5 million in previous year. We now estimate Turkish Airlines will carry 42.2 mn international March THY February-18 traffic passenger and 33.1 mn domestic passenger, overall resulting to April, 9th Market traffic results (March) 9.7% YoY passenger growth and improvement of 2.9 ppt in load factor to 82.1% in 2018E vs 79.1% in 2017. Although we revised up our revenue estimate of 2018E much by 6.7%, we cut down EBITDA margin estimate by 1ppt on the back of upward revision in our oil estimates and ex-fuel CASK by 5.9% after 4Q17 results Key Data performing worse than our estimates. Accordingly, we project THY to generate 13.2% revenue and 9.9% EBITDA CAGR over our Ticker THYAO forecast period (2017-2019E). Share price (TL) 17.37  There is still room for improvement on our assumptions. The 52W high (TL) 19.57 shares have gained 10.7% so far this year outperforming the 52W low (TL) 5.38 benchmark BIST 100 index by 9.4 percentage points. THYAO is Market Cap (TLm) 23,971 trading at 6.5x on one-year forward EV/EBITDA, at 8% below its 5- Market Cap (USDm) 6,310 year historical average multiple, or at 5% to its emerging market Free float (%) 50.88 peers’ median. Consensus TP (TL) 18.04  Valuation. Our price target is based on a combination of DCF and Consensus rating 73% B / 27% H / 0% S target EV/EBITDA multiple with respect to 80:20 weights. Our DCF 3M ADV (USDm) 249.3 model points to a 12-month target share price of TL18.90 implying HY EPS (2018E) 2.16 a 9% upside potential. On the multiple part, we use 2018E target Consensus EPS (2018E) 1.64 EV/EBITDA of 7.0x historical five-year median, values THYAO at TL22.30, implying a 28% upside potential, assuming 12-month target currency of USD/TRL at 4.02.

 Key risks. An unexpected increase in geopolitical tension, lower Price performance than our expected load factors, passenger growth, ticket prices, unexpected hikes in fuel prices, value-destructive M&A and 22 20 negative surprise in the value of US dollar are the main downside 18 risks to our model. 16 Forecasts and Ratios 2015A 2016A 2017A 2018E 2019E 14 12 Revenues (USDmn) 10,522 9,792 10,958 12,541 14,043 10 8 EPS (basic,USD) 0.77 -0.06 0.16 0.56 0.64 6 EPS (fully-diluted,USD) 0.77 -0.06 0.16 0.56 0.64 4 BVPS (USD) 3.51 3.69 3.87 4.43 5.07 03-17 05-17 07-17 09-17 11-17 01-18

PER (x) 5.9x -82.0x 28.3x 8.2x 7.2x Price BIST100 (Rebased) PBR (x) 1.3x 1.2x 1.2x 1.0x 0.9x EV/Sales (x) 1.3x 1.4x 1.2x 1.1x 0.9x EV/EBITDA (x) 8.2x 16.6x 7.1x 6.5x 5.9x Analyst: Abdullah Demirer [email protected] : +902123148724

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Figure 1 : Foreign Arrivals Breakdown Figure 2 : European Arrivals YoY

40% 40% 34% 27.8% 30% 30% 21% 20% 20% 13% 12% 8% 10% 7% 10% 5.5% 1% 3% -1.6% 0% 0% 3.5% -2% -0.1% -10% -6% -10% -1.8% -9% -20% -14% -20% -19% -19% -20% -30.1% -30% -24% -25% -30% -29% -30% -40% -33% -33%-33% -31.1% -37% -38%-37% -40% -50% 2014 2015 2016 2017

Europe Total

07.2016 08.2016 09.2016 10.2016 11.2016 12.2016 01.2017 02.2017 03.2017 04.2017 05.2017 06.2017 07.2017 08.2017 09.2017 10.2017 11.2017 12.2017 01.2018 01.2016 02.2016 03.2016 04.2016 05.2016 06.2016

Source: Ministry of Culture and Tourism, Halk Invest

Although foreign arrivals recovered much by 27.8% YoY in 2017 almost in all regions, European arrivals stayed flattish in 2017. Our conversations with Association of Turkish Travel Agencies claimed that summer bookings from Western Europe has jumped much by around 60% YoY for 2018, where German arrivals lead the figures. Moreover, last minute reservations also increased to 60-70% from 20-30% in the last couple years. Furthermore, Afrin operation did not affect the reservations. Last but not least, early reservation figures show that domestic tourist numbers increased to 6 million from 5 million in previous year. Thus we now estimate the domestic passenger number will record 9.7% YoY in 2018E after 10.3% YoY growth in 2017.

European passenger figures jumped 35% YoY according to Turkish Airlines Jan., 2018 traffic data and led total O&D passenger to grow 45% YoY. Taking into account the jump in summer bookings, European arrivals would increase c.33% YoY growth in 2018 and will lead international passengers of Turkish Airlines to increase c.10% YoY in 2018. Therefore we updated our 2018E international passenger estimates by 0.6% to 42.2 mn which stands out at 41.0 mn in company management guidance. Note that, direct passenger constitute 45% of the Europe routes and have 20-30% higher yield than the transfer passengers’. Therefore, we upgraded our passenger revenue yields by 5.0% to 7.26 Usc from 6.92 Usc.

We now estimate company will generate USD12,541 mn in 2018E implying 14% YoY growth on the back of mainly upward revision of our total passenger numbers. On the other hand, we update our expense estimates derived mainly worse than our estimates in 4Q17 and upward revision in our average Brent price estimates. According to our estimates, CASK growth would record 8.2% YoY to 6.35 Usc in 2018E from 5.87 Usc in 2017. As a result, our 2018E estimate slightly increased to USD2,040 mn in 2018 by 0.7%.

We upgrade our 2018E assumption of average Brent price to 62.0 USD/bbl from 56.0 USD/bbl to incorporate recent improvement in oil prices, which leads our average fuel price estimate for the company, including hedge, to increase to 653 USD/ton. Having that 60% of fuel cost is hedged by decreasing layered hedging strategy for the following 24 months, over ICE Brent derivatives, we calculate company already hedged 45% of its 2018E fuel consumption at 53.3 USD/bbl, which will provide shield for the company’s operating profitability.

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Figure 3 : Changes in our estimates

2018E 2019E USD mn Old New Change Old New Change Sales 11,750 12,541 6.7% 13,477 14,043 4.2%

EBITDA 2,026 2,040 0.7% 2,023 2,248 11.1%

Margin 17.2% 16.3% -1 pp 15.0% 16.0% 1 pp

Net Income 798 767 -3.9% 765 881 15.2%

Margin 6.8% 6.1% -0.7 pp 5.7% 6.3% 0.6 pp

Source: Halk Invest

We now estimate the company to generate 6.7% more sales revenue in 18E on the back of upward revisions in our total pax estimates. We also upgraded our top-line estimates of 19E, mostly derived from cargo volume upward revision and domestic passenger upward revision assuming domestic passenger market share gain of the company in 2018E will remain. On the other hand, we cut down our total international passenger estimates by 4.1% on the back of downward revision of authority estimates by 10.9% in 2019E.

Figure 4 : Our estimates versus the consensus THYAO Halk Invest Bloomberg Difference (TL mn) 2018E 2019E 2018E 2019E 2018E 2019E Sales 48,784 56,451 45,560 51,556 7% 9% EBITDA 7,937 9,035 7,616 8,619 4% 5% Net Income 2,982 3,541 2809 3,142 6% 13% EBITDA Margin 16.3% 16.0% 16.7% 16.7% -0.4 p -0.7 p Net Income Margin 6.1% 6.3% 6.2% 6.1% -0.1 p 0.2 p Source: Bloomberg, Halk Invest

Figure 5 : Our estimates versus FY2018 THY guidance 2018E Company Target Halk Invest Difference Sales (Solo - USD bn) 11.8 12.2 3.2% EBITDAR Margin (Solo) 21%-22% 23.7% - EBITDAR Margin (Consolidated) 23%-24% 24.5% - CASK (YoY Change) %3-%5 5.6% -

ASK (bn) 183 183.1 0.1% Total Pax (Million) 74 75.3 1.8% Domestic 33 33.1 0.2%

International 41 42.2 3.0%

Load Factor 79-80% 82.1%

Cargo (000 Tonnes) 1,300 1,349 3.7% Average Jet Fuel 633 USD 656 USD 3.7% (including fuel hedge)

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Figure 6 : EV/EBITDA 18E Figure 7 : EV/Sales 18E

THY 6.5 THY 1.1 EM Median 6.8 EM Median 1.0 Global Median 5.5 Global Median 0.8

Eva 5.7 Eva 0.7 China 7.1 China 0.9 Korean 6.1 Korean 1.3 Asiana 7.7 Asiana 0.8 IAG 3.5 IAG 0.6 Air France 2.0 Air France 0.3 Lufthansa 2.8 Lufthansa 0.4

0 2 4 6 8 10 0.0 0.5 1.0 1.5

Source: Bloomberg, Halk Invest Following our EBITDA revisions, Turkish Airlines is currently trading at 6.5x and 2018E EV/EBITDA discount at c.5% to its emerging market peers’ median. Additionally, the share is trading discount at 8% to its 5-year historical average multiple of 7.0x.

Valuation. We base our valuation for Turkish Airlines with a combination of DCF and target EV/EBITDA multiple with respect to 20:80 weights. Our DCF model points to the 12-month target share price of TL18.90 implying a 9% upside potential. On our DCF model, we use a USD-based model with the assumptions of a 2% terminal growth rate, a Beta of 1.10, a market risk premium 5.5%, a risk free rate 6.0%, long- term EBITDA margin assumption of 14.6% (from 13.8%).

On the multiple part, we use 2018E target EV/EBITDA of 7.0x historical five-year median. Our multiple model values THYAO at TL22.30, implying a 28% upside potential.

As a result, our weighted valuation model indicates the 12-month target share price of TL21.60, assuming a 12-month target currency of USD/TRL at 4.02.

Risks. An unexpected increase in geopolitical tension, lower than our expected load factors, passenger growth, ticket prices, unexpected hikes in fuel prices, value- destructive M&A and negative surprise in the value of US dollar are the main downside risks to our model. THYAO : 1yr forward P/E THYAO : 1yr forward EV/EBITDA

41 16 39 37 15 35 14 33 31 13 29 27 12 25 11 23 21 10 19 9 17 15 8 13 7 11 9 6 7 5 5

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07.2013 11.2013 03.2014 07.2014 11.2014 03.2015 11.2015 07.2016 07.2017 11.2017 03.2013 07.2015 03.2016 11.2016 03.2017

03.2013 07.2013 11.2013 03.2014 11.2014 03.2015 07.2015 07.2016 11.2016 03.2017 11.2017 07.2014 11.2015 03.2016 07.2017

Source: Bloomberg, Halk Invest

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Operational and financial estimates 2017A 2018E 2019E 2020E # of total passengers 68.6 75.3 81.9 86.9 Old 73.2 81.7 86.7 Change 2.9% 0.1% 0.2%

# of int'l passengers 38.5 42.2 47.3 50.2 Old 42.0 49.4 53.1 Change 0.6% -4.1% -5.4%

# of domestic passengers 30.1 33.1 34.5 36.7 Old 31.2 32.4 33.6 Change 5.9% 6.5% 9.1%

Passenger growth YoY 9.3% 9.7% 8.7% 6.1% Old 6.7% 11.7% 6.0% Change 3.1 ppt -3 ppt 0.1 ppt

Load factor 79.1% 82.1% 83.1% 79.5% Old 81.1% 77.7% 77.8% Change 1 ppt 5.5 ppt 1.8 ppt

Passenger R/Y (USc) 7.03 7.26 7.24 7.09 Old 6.92 6.71 7.02 Change 5.0% 7.9% 1.1%

ASK (bn) 173.1 183.1 201.6 224.5 Old 184.7 226.5 245.9 Change -0.9% -11.0% -8.7%

CASK (USc) 5.87 6.35 6.47 6.22 Old 5.84 5.57 5.88 Change 8.8% 16.1% 5.7%

Ex-fuel CASK (USc) 4.22 4.45 4.50 4.42 Old 4.21 3.96 3.94 Change 5.9% 13.7% 12.1% RASK (USc) 5.95 6.39 6.55 6.16 Old 6.01 5.65 5.91 Change 6.3% 15.9% 4.2%

Revenue (USD mn) 10,958 12,541 14,043 14,730 Old 11,750 13,477 15,302 Change 6.7% 4.2% -3.7%

EBITDA 1,860 2,040 2,248 2,152 Old 2,026 2,023 2,141 Change 0.7% 11.1% 0.5%

Net Income 223 767 881 679 Old 798 765 804 Change -4.0% 15.2% -15.6%

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Financials & forecasts

THYAO (Consolidated) 2014A 2015A 2016A 2017A 2018E 2019E Financials and Forecasts (USD mn) Sales 11,070 10,522 9,792 10,958 12,541 14,043 COGS -9,030 -8,420 -8,656 -8,762 -10,043 -11,303 Gross income 2,040 2,102 1,136 2,196 2,498 2,740 Opex -1,399 -1,420 -1,486 -1,402 -1,590 -1,739 EBITDA 1,384 1,606 798 1,860 2,040 2,248 Depreciation -743 -924 -1,148 -1,066 -1,133 -1,247 EBIT 641 682 -350 794 908 1,001 Net financial income 223 331 71 -1,022 -252 -237 Net other income 182 394 220 507 327 366 EBT 1,046 1,407 -59 279 983 1,129 Tax -201 -338 -18 -56 -216 -248 Net income 845 1,069 -77 223 767 881 Minorities 0 0 0 0 0 0 Net income after minorities 845 1,069 -77 223 767 881 Dividends paid out 0 0 0 0 0 0 Retained earnings 845 1,069 -77 223 767 881 Total assets 13,746 16,383 18,491 18,197 18,880 20,727 Cash and securities 723 963 1,862 2,137 1,818 2,426 Fixed assets 9,201 11,415 13,476 13,002 13,371 14,300 Inventories 195 216 217 193 221 249 Total debt 5,950 7,664 10,247 9,070 8,533 9,036 Book equity 3,950 4,842 5,087 5,346 6,113 6,994 Market equity 5,687 3,496 2,756 3,087 6,316 6,316 MV of net debt 5,227 6,701 8,385 6,933 6,715 6,610 Minorities 0 0 0 0 0 0 Enterprise value 10,914 10,197 11,141 10,020 13,032 12,926

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Financials & forecasts

Margins 2014A 2015A 2016A 2017A 2018E 2019E Gross 18.4 20.0 11.6 20.0 19.9 19.5 EBITDA 12.5 15.3 8.1 17.0 16.3 16.0 EBIT 5.8 6.5 -3.6 7.2 7.2 7.1 EBT 9.4 13.4 -0.6 2.5 7.8 8.0 Net 7.6 10.2 -0.8 2.0 6.1 6.3 Depreciation 6.7 8.8 11.7 9.7 9.0 8.9 Inventories 1.8 2.1 2.2 1.8 1.8 1.8 Opex 12.6 13.5 15.2 12.8 12.7 12.4 Financing -2.0 -3.1 -0.7 9.3 2.0 1.7 Cost of funding (net) -4.3 -4.9 -0.8 14.7 3.7 3.6 Profitability 2014A 2015A 2016A 2017A 2018E 2019E Asset turnover 80.5 64.2 53.0 60.2 66.4 67.8 ROA 6.1 6.5 -0.4 1.2 4.1 4.3 ROE 21.4 22.1 -1.5 4.2 12.5 12.6 Leverage ratios 2014A 2015A 2016A 2017A 2018E 2019E Debt/Assets 43.3 46.8 55.4 49.8 45.2 43.6 Debt/Equity 150.6 158.3 201.4 169.7 139.6 129.2 Net debt/Equity 1.3x 1.4x 1.6x 1.3x 1.1x 0.9x Net debt/EBITDA 3.8x 4.2x 10.5x 3.7x 3.3x 2.9x Dividend pay-out 0.0 0.0 0.0 0.0 0.0 0.0 Per share data and multiples 2014A 2015A 2016A 2017A 2018E 2019E EPS (USD) 0.61 0.77 -0.06 0.16 0.56 0.64 BVPS (USD) 2.86 3.51 3.69 3.87 4.43 5.07 DPS (USD) 0.00 0.00 0.00 0.00 0.00 0.00 CFPS (USD) -0.10 0.29 -0.35 0.46 -0.10 0.32 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0 Earnings yield (%) 13.4 16.9 -1.2 3.5 12.1 13.9 FCF yield (%) -2.2 6.3 -7.6 10.1 -2.3 7.0 EV/Sales 1.2x 1.3x 1.4x 1.2x 1.1x 0.9x EV/EBITDA 9.6x 8.2x 16.6x 7.1x 6.5x 5.9x P/FCF -46.4x 15.9x -13.2x 9.9x -43.7x 14.3x PER 7.5x 5.9x -82.0x 28.3x 8.2x 7.2x PBR 1.6x 1.3x 1.2x 1.2x 1.0x 0.9x

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Halk Invest Rating Definitions

We rate a stock BUY if we see 15% or more upside in shares. Any upside between 1% and 15% merits a HOLD rating. We rate a stock SELL if our target value is below the current market value.

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Banu Kivci Tokali Serhan Yenigün Alpogan Sabri Erdogan Head of Research Energy & Utilities Head of Financial Markets Chief Economist Strategy +90 (212) 314 8182 [email protected] [email protected] [email protected]

Ilknur Turhan Ugur Bozkurt Nazan Ozdemir Generalist, Macro Research Sales Building Materials [email protected] +90 (212) 314 8184 [email protected] [email protected]

Abdullah Demirer Industrials, Mid-caps [email protected]

Disclaimer

This report has been prepared by Halk Yatırım Menkul Değerler A.Ş. (“Halk Invest”), solely to provide information to the recipient as of the date of issue and are subject to changes without prior notice. The comments, estimates and recommendations included herein do not constitute an offer or an invitation to buy or sell any security. The advice given in this document is not a part of investment advisory activity. Investment advisory services are given according to the investment advisory contract, signed between the authorised institution and the client. The information presented in this report has been obtained from published information and other sources which Halk Invest considers to be reliable. Halk Invest does not accept any liability or responsibility for the accuracy or completeness of any such information. The opinions discussed in this report may not be appropriate for all investors. Transactions in securities, instruments or investments to which it refers to can involve high risks, therefore it is highly recommended that investors make their own investment decisions based on their specific investment objectives, financial positions and risk profiles. Halk Invest and its affiliated organisations and persons may, from time to time, take position on any of the securities covered herein and may buy or sell those securities or their derivative securities either on their own account and / or on behalf of their clients. All information in this document remains as the property of Halk Invest and must not be reproduced under any circumstances, not to be copied or made available to any person other than the recipient.

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