GENEL-PUBLIC March 8, 2018 Equity Research Turkish Airlines 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 Turkey 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 Europe 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] Istanbul: +902123148724 1 GENEL-PUBLIC GENEL-PUBLIC 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. 2 GENEL-PUBLIC GENEL-PUBLIC 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) 3 GENEL-PUBLIC GENEL-PUBLIC 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.