SECTOR REPORT Equity TURKEY/AVIATION Research October 25, 2018
TURKISH AVIATION
More exposed to foreign demand than domestic CLEBI HOLD Attractive from a long-term perspective. In light of changes to our Price Data
assume lower load factors, particularly on the domestic front, to
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May-15 May-16 May-17 May-18 capture macro uncertainties. Moreover, we do not fully reflect the CLEBI PGSUS TAVHL THYAO positives of airlines’ higher international focus. We think the additional level of deterioration could only be justified by worse than expected foreign demand as experienced in 2016, and we see no valid reason currently to anticipate a similar downturn. Does TRY really matter? Our statistical findings suggest that the market might be overplaying the adverse impact of weak TRY on locals’ travel appetite. Meanwhile, FX levels do not seem to be the foremost critical determinant on foreign demand as well which is more crucial for airlines and we did not find strong empirical evidence to support such a claim. We conjecture that security Mustafa Görkem Göker conditions might be playing a more important role in that respect. [email protected] +90 212 319 7949
IMPORTANT: Please refer to the last page of this report for “Important Disclosures” and Analyst(s) Certifications.
25 October 2018– Aviation
EXECUTIVE SUMMARY The Turkish aviation sector has experienced an unprecedented recovery since 1H17 following historic contraction in the prior 1.5 years on macro and geopolitical headwinds. After dropping c.30% in 2016 to 25.3mn, the total number of annualized foreign arrivals to Turkey reached its historical high of 37.5mn as of end-Aug’18 on a c.50% increase in line with normalization and a weaker TRY. Domestic demand, on the other hand, relatively more resilient given the immature nature of the market, grew 13% in the same period. Such volume recovery translated into significant improvement in all listed aviation names’ profitability thanks to the capital intensive and high fixed cost nature of the aviation sector, where high utilization rates are a must for sustainable and profitable growth. We calculate c.25% USD-revenue growth on a trailing basis as of end-2Q18, vs. end-2016 for our aviation coverage and c.6.0pp EBITDA margin improvement during the same period. Going forward, we expect Turkish air carriers, but particularly Turkish Airlines, to refrain from accelerating new capacity introduction starting from 4Q18, if not y/y contraction in the very short-term till 2H19, due mainly to (i) uncertainty over the timing and ramp-up period of operations at the new Istanbul airport, which is currently scheduled for end- 2018, (ii) a challenging macro environment, including potential weakness in domestic consumption, (iii) higher jet fuel prices and, (iv) a relatively high base effect of 2018. Yet, higher than expected international demand directed to Turkey poses the major upside risk to our expectation because as long as air carriers are convinced that faster capacity introduction will not hurt their intl’ load factors (currently >80%), they would be ready to increase capacities. Accordingly, we expect the largest two carriers in the market, namely Turkish Airlines and Pegasus to introduce c.6% higher number of flights in 2019, similar to 2018, but with a different mixture (i.e. c.12% increase in intl’ flights, but 1% reduction in domestic flights). Meanwhile, we do not expect foreign carriers to be in a hurry to increase their Istanbul flights till they are convinced about the new airport which would soften yields and load factor pressure on Turkish carriers. Our relatively slower new capacity introduction expectation at a time jet fuel prices have risen c.40% over the past year, and a sizeable adjustment is awaited for TRY- denominated costs, especially for personnel costs after the spike in CPI, prompt us to lower our previous margin forecasts by c.4.0pp on average. However, our new forecasts still suggest above-historical average levels for all players of above our earlier estimates. Moreover, we argue that unless there is a major interruption in foreign air travel demand to Turkey, as in 2016, and a change in the current FX revenue-cost stream, a sharp negative stance for the margin outlook of the sector on a high cost basis and weak domestic demand would be unwarranted. We stress not to overlook of the positive impact of change in capacity mix for airlines. For us, the foremost risk ahead of the sector is any interruption in foreign demand. Other than potential loss in Russian arrivals to Egypt due to the re-launch of charter flights between the two countries, we do not see a major threat on that front, but rather an opportunity on weak TRY. Meanwhile, we also consider any type of intervention in free market practices even voluntarily by airlines, such as Atlas Global’s current 20% price reduction till end-2018 within the context of the national fight against inflation or no adjustment in TRY350 per domestic ticket price cap by the government as other risk factors. Aviation pricing is not formulated as simply ‘costs+mark up,’ but rather, based fully on the market dynamics of each and every route. Moreover, the pricing differs greatly among airlines according to their value proposition (whether they are a network carrier, or an LCC, and according to the type of passenger, economy or business, direct O&D, or transfer). Accordingly, we would find any continuation of such arbitrary measures highly value-destructive, and a valid reason to avoid sector.
25 October 2018– Aviation VALUATION We re-visited our valuations for aviation stocks under our coverage due mostly to changes in our macro assumptions and valuation metrics, particularly FX levels, inflation and risk-free rate as well as our volume forecasts in light of traffic developments since our latest update. In general, we continue to favor the sector thanks mainly to its export-oriented nature, suggesting relative resilience against lower domestic consumption and benefit from weaker TRY against hard currencies.
Table 1: Overview of target price and recommendations
New Return Old Current Target Potential New Target Old Ticker Price Price (*) Rating Price Rating CLEBI 59.3 62.5 14% Hold 51.00 Buy PGSUS 21.3 32.7 51% Buy 38.56 Hold TAVHL (**) 4.1 4.5 15% Hold 5.50 Hold THYAO 15.5 20.6 33% Buy 19.50 Buy
Source: YKY Research (*) including 2018e dividend yield (**) all in EUR
The main drivers of our target price are our new FX assumptions, higher risk free rates for service companies (CLEBI and TAVHL) and lower benchmark multiple for airlines (PGSUS and THYAO). - Based on our revised macro estimates, we assume c.30% weaker TRY on avg. for 2018 and c.60% on avg. for 2019 against the EUR-USD basket, the main driver of acceleration in revenue growth in TRY terms. - Our macro team now foresees lower GDP growth for both 2018 and 2019 and expects avg. CPI to hit c.23% in 2019, vs. c.10% previously. Accordingly, we now assume a lower level of passenger growth for domestic lines and higher level of inflation adjustment for TRY-denominated costs. - In light of Turkey’s rising risk premium, we also increase our risk free rate to 18% (prev. 14%) and incorporate higher level of borrowing costs to our models. We also roll over our target prices by using our end-2018 net debt estimate and value airlines by 2019e adj. EV/EBITDAR (previously 2018e). - Lastly, we reduce our target benchmark of 6.0x to 5.5x for airlines on the back of deterioration in their ROCE profile for 2019 and incorporate the macro risks, especially rising cost of capital.
Table 2: Reasons Behind Target Price Changes Change Change New Old in DCF in Target Target Macro Metrics Multiple Ticker Price Price Change Assum. (*) (**) Others CLEBI 62.5 51.0 23% 44% -36% 0% 14% PGSUS 32.7 38.6 -15% -46% 0% -19% 49% TAVHL (***) 4.5 5.5 -18% 1% -7% 0% -12% THYAO 20.6 19.5 6% 9% 0% -19% 16%
Source: YKY Research (*) including risk free rate, beta, D/E weight and terminal growth (ii) adj. EV/EBITDAR of 5.5x currently vs. 6.0x previously (***) all are in EUR
25 October 2018– Aviation - CELEBI
25 October 2018– Aviation
VALUATION SUMMARY
25 October 2018– Aviation
INDUSTRY OUTLOOK
Encouraging volume growth... Turkish aviation had experienced a steep decline in passenger traffic starting from late-2015 till mid-2017 on certain adverse macro developments and geopolitical risks, including the downing of a Russian jet, the Reina nightclub attack in Istanbul, the electronic equipment ban for US-flights, a failed coup attempt…etc. However, since mid-2017, in line with normalization on the macro front and the realization of postponed demand, the sector has more than recovered its losses. After dropping c.30% in 2016 to 25.3mn, the total number of annualized foreign arrivals to Turkey reached its historical high of 37.5mn as of end-Aug’18 on c.50% increase. While Russian arrivals played the major role behind recovery at the consolidated level, the gradual recovery in European arrivals, traditionally the foremost market for Turkey, also contributed positively to overall growth.
Chart 1: Arrivals to Turkey
Foreign Arrivals by air vs. Intl’ Load Factor (*) Stake in Total Arrivals
Source: www.kultur.gov.tr, YKY Research (*) total of only Pgsus and Thyao The aforementioned recovery in international volumes has been the foremost factor behind aviation names’ strong financials and historic-high margins over the past couple of quarters, and probably in the upcoming 3Q18e financials. This is because aviation is a highly capital intensive sector where costs are mostly fixed in nature, and the higher the utilization rate the more profitable companies are.
To put it into numbers, Turkish Airlines posted an 81.1% intl’ load factor on a trailing basis as of end-Sep’18, while Pegasus announced a 82.4% intl’ load. When compared to their end-2016 levels, these realizations suggest 8pp and 10pp improvement, respectively. Accordingly, such improvement in one of the most crucial KPIs enables both airlines to post c.25%% and c.40% EBITDA CAGRs and c.7.0pp margin improvement. Meanwhile, certain other factors, namely (i) weaker TRY, (ii) relatively modest capacity introduction than in the recent past, and (iii) company-specific measures to lower unit costs further supported margin improvement.
25 October 2018– Aviation
Chart 2: Airlines KPIs
Pegasus Airlines Turkish Airlines
Source: Companies, YKY Research All in all, the encouraging recovery in international air travel demand to/from Turkey since mid-2017 has been greatly reflected into aviation companies’ financials, and unless we see interruption on that front, we expect no material deterioration going forward.
…likely to prevail at a declining pace. We expect Turkish air carriers not to be greatly enthusiastic in accelerating their current pace of new capacity introduction in the near term, especially over the next couple of quarters till 2H19, or say, the beginning of 2020. Apart from seasonal factors, uncertainties related to the opening time of the new airport in Istanbul, the challenging domestic macro environment, upward trend in jet fuel prices, high base of 2018 and relatively lower capacity remaining at Sabiha Gokcen are the main reasons behind our modest capacity introduction estimate for the near-term.
Chart 3: Airlines Capacity Mix (Number of Landings)
Pegasus Airlines Turkish Airlines
Source: www.kultur.gov.tr, YKY Research
25 October 2018– Aviation
Our current assumptions imply that the two main Turkish carriers, namely Turkish Airlines and Pegasus will introduce c.6% greater number of flights in 2019 and carry c.5% more passengers in the same period. On the other hand, we believe that major foreign carriers, especially those offering scheduled flights, will prefer to wait and see the operating environment in the post-new airport era, as well as the finalization of the ramp-up period at the airport, and as such will be reluctant to introduce new capacities initially.
Consequently, we expect the Turkish aviation sector to post 7% consolidated passenger growth in 2019, vs. our 10% growth forecast for 2018 where international lines would remain the key growth driver.
…retreat in margins is likely but to what extent? We expect listed aviation names to have posted 2.4pp y/y EBITDA margin improvement on average by end-2018, followed by c.4.0pp y/y contraction in 2019e. The major reasons behind our cautious stance for the margins, despite ongoing high international demand are as follows: (i) adjustments in TRY-based costs due to a current high inflation environment, particularly on staff front, which would take place with a lag (ii) weak domestic demand on slower economic growth from 3.3% in 2018e to 0.5% in 2019 (iii) higher jet fuel prices, which would be more challenging to reflect to ticket fares in a slowing economy (iv) y/y weaker EUR/USD, particularly in 1H19, which is margin-dilutive due to the relative dependence on EUR in revenues, but USD in costs, (v) heightened cost base for THY and Celebi after relocating to the new airport, the dilutive impact of which could only end once the airport is be fully operational in the mid to long-term and (vi) 2018’s high base effect as current above-historic margins are hard to sustain.
Having outlined the challenges to the sector’s yield and margins going forward, we argue that there are some company specific catalysts which would prevent aviation companies from further level of contraction, if not attain improvement.
- Firstly, for airlines, capacity mix in favor of intl’ lines and capacity discipline with utmost focus on CASK are important tools.
- Secondly, weak TRY would ultimately mitigate the margin pressure to a large extent for Celebi, TAV and Turkish Airlines though to a lesser extent for Pegasus as a result of their current FX revenue-cost stream.
- Thirdly, the contribution from foreign subsidiaries, particularly for Celebi and TAV, would compensate potential losses in the domestic market.
- Last but not least, other than the potential negative impact of the initiation of Russian charter flights to Egypt, we see no similar reasons like those observed in 2015-16 to anticipate a dramatic downturn in foreign arrivals to Turkey, and this would limit further deterioration in profitability than our current estimates for 2018.
All in all, we foresee a more challenging operating environment for the sector in 2019e, mostly on a higher cost basis, but continuation of current high international demand and a weak TRY would prevent aviation companies from experiencing any material margin contraction, thereby keeping them above historical averages, but lower than 2018e levels.
25 October 2018– Aviation
Any limitation on pricing would be highly value destructive… In mid-October, Atlas Global, Turkey’s 4th largest airline, announced that it would reduce all its domestic air ticket prices by 20% till Dec 27, 2018 to support the government’s efforts to curb inflation. There is similar news flow in the media claiming that the remaining players’ plan to implement such reductions. Our views on the issue are as follows:
- Firstly, there is already a price ceiling on domestic flights at TRY352, which has not changed since 2017, despite c.40% rise in jet fuel prices over the past one year. We are unsure as to whether it would be re-visited in 2019, but it appears unlikely to see a revision in the current environment.
- Secondly, we find such arbitrarily set price ceilings and reductions value destructive for the sector, lacking very basic pricing dynamics. That is, air ticket fares are set solely based on market dynamics and demand/supply conditions for each and every destination. Moreover, many airlines, but particularly network carriers relying on transfer passenger traffic, evaluate overall network profitability, rather than a route-by-route basis, and theoretically, each passenger might have been charged different fares for the very same flights. Thus, applying an arbitrarily set 20% reduction in such a dynamic pricing mechanism would offer nothing but lower profitability for airlines’ domestic flights, and considering the already high level of domestic load factors, at c.8%, there is very limited room for attracting higher demand by offering lower price.
- Thirdly, one might consider such out of blue interventions on pricing would hurt all carriers’ margins to a certain extent, but mostly for Pegasus due to its relatively high dependence on the domestic market. We would agree with that proposition with some reservations. That is, our models also suggest that 10% deviation from our base case domestic air ticket fares for Pegasus and Turkish Airlines translates into a 1.7% and 0.8% drop in their consolidated revenues and 1.4pp and 0.7pp EBITDA margin erosion, respectively. Yet, our reservation is that Pegasus’ domestic average ticket fares are already c.40% lower than Turkish Airlines on average, and the need for a discount, at times of weak domestic demand, might be more costly for Turkish Airlines.
All in all, we would perceive any long-lasting implementation of lower prices in the domestic market in order to prevent higher inflation as negative, the adverse consequences of which would ultimately necessitate local carriers to adjust their prices at a higher magnitude going forward, because we see no easing in costs, especially on jet fuel, that would justify such policy. Accordingly, we foresee a negative impact on short-term financials, say in 4Q18, but expect it to gradually disappear in line with reversion to basic pricing principles in the aviation sector of all parties.
25 October 2018– Aviation APPENDIX 1: International Peer Comparison (Airlines)
25 October 2018– Aviation APPENDIX 2: International Peer Comparison (Terminal Operators)
25 October 2018– Aviation APPENDIX 3: Measuring the Impact of Exchange Rate Developments on Visitors (by air) by Eren Ocakverdi
It is always convenient to assume an intuitive or a desired relationship among the variables of interest as if it’s a fact without bothering to check whether it actually holds. This is a result of several cognitive biases, which are very hard to escape. In our case, for instance, it seems quite obvious to assume that depreciation in local currency would lead to a surge in the visitors from abroad. In order to avoid a possible inferential trap, we would like to dig deeper into this claim.
We are especially interested in the behavior of visitors by air (see Chart 1). A further breakdown of citizens (as locals and expats) would be fine, but it is hard to compile the data and the official figures are announced on quarterly basis.
Chart 1. Visitors by air (millions)
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Foreigner Citizen (right scale)
By visual inspection, we see that both indicators are trending and have strong seasonality. You obviously notice the odd one out in the sequence above and probably remember the chain of events following the downing of a Russian fighter jet in November 2015. We need to control all these effects in order to isolate the impact from exchange rates, if any.
We’ll use the data between January 2010 until August 2018, since the timing and magnitude of seasonal fluctuations might change during longer periods than 8 to 10 years. Moreover, we’ll also work on the seasonally adjusted data in order to avoid running out of degrees-of-freedom. We prefer breakpoint regression to model the foreign visitors by air, since we suspect that the parameters vary across observations
25 October 2018– Aviation
(i.e. at dates in the sample period):
〖 log(foreigners_adj)〗 _t=α^j+β^j*〖 trend〗 _t+γ^j*〖 depreciation〗 _t+ε_t
Here, superscript j denotes regimes with respect to identified breakpoints. Depreciation is defined as the annual percentage change in USDTRY exchange rate and trend is a simple time variable. Model identifies two breakpoints: November 2014 and April 2016. And the depreciation effect is “statistically” significant (positive) only during this period (see Chart 2).
Chart 2. Breakpoint regression result (foreigners by air) 14.8 14.6 14.4 14.2 .2 14.0 .1 13.8 .0
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-.2 2010 2011 2012 2013 2014 2015 2016 2017 2018
Residual Actual Fitted
As for citizens (by air), we could not identify any breaks in the data nor found a significant impact of the exchange rate. So a simple OLS would suffice:
〖 log(citizens_adj)〗 _t=α+β*〖 trend〗 _t+γ*〖 depreciation〗 _t+ε_t
Nothing is interesting in the results of the model above as visitors seem to follow their trend (see Chart 3). However, the most recent overshoot of fitted model may be a direct consequence of an exchange rate shock and we wonder if it will resemble to that of our conflict with Russia back in 2016. In that case, we would expect the total number of citizen visitors by air to be at least 5% below its potential over a 12 month period.
Our results do not suggest that there is “no relationship” between the exchange rate depreciation and the number of visitors by air. Instead, our findings do not strongly support in favor of a causality from exchange rate. There may be such a relationship, but we cannot easily identify it through our simple empirical models applied to data. It is also possible that despite being one of the drivers, visitors’ decision making may depend on a number of other (more important) factors, which are difficult to measure or control.
25 October 2018– Aviation Chart 3. OLS regression result (citizens by air) 13.8 13.6 13.4 13.2 .2 13.0 .1 12.8
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Residual Actual Fitted
25 October 2018– Aviation
APPENDIX 4: Consensus vs. YKY Research
CLEBI Bloomberg YKY Difference (TRYmn) 2018e 2019e 2018e 2019e 2018e 2019e Net Sales 1,387 1,951 1,366 1,934 -2% -1% EBITDA 343 472 328 385 -4% -18% Net Profit 149 264 112 147 -25% -44% Margins (%) EBITDA Margin 24.7 24.2 24.0 19.9 -0.7 pp -4.3 pp Net Margin 10.7 13.5 8.2 7.6 -2.6 pp -5.9 pp
PGSUS Bloomberg YKY Difference (TRYmn) 2018e 2019e 2018e 2019e 2018e 2019e Net Sales 8,222 10,427 8,324 11,814 1% 13% EBITDA 1,107 1,280 1,289 1,508 16% 18% Net Profit 400 398 556 371 39% -7% Margins (%) EBITDA Margin 13.5 12.3 15.5 12.8 2 pp 0.5 pp Net Margin 4.9 3.8 6.7 3.1 1.8 pp -0.7 pp
TAVHL Bloomberg YKY Difference (TRYmn) 2018e 2019e 2018e 2019e 2018e 2019e Net Sales 7,783 7,560 6,901 9,780 -11% n.m. EBITDA 3,742 4,223 3,557 5,042 -5% n.m. Net Profit 1,614 1,934 1,375 2,000 -15% n.m. Margins (%) EBITDA Margin 48.1 55.9 51.6 51.6 3.5 pp -4.3 pp Net Margin 20.7 25.6 19.9 20.4 -0.8 pp -5.1 pp
THYAO Bloomberg YKY Difference (TRYmn) 2018e 2019e 2018e 2019e 2018e 2019e Net Sales 62,230 79,586 63,716 93,208 2% 17% EBITDA 10,807 13,086 12,044 13,683 11% 5% Net Profit 3,645 4,130 4,340 2,873 19% -30% Margins (%) EBITDA Margin 17.4 16.4 18.9 14.7 1.5 pp -1.8 pp Net Margin 5.9 5.2 6.8 3.1 1 pp -2.1 pp
Source: Bloomberg, YKY (*) Our 2019 numbers for TAV assumes as if the company operates IST
25 October 2018– Aviation
AVIATION COVERAGE UNIVERSE
COMPANY UPDATE Equity (Rating Change) Research TURKEY 25 October 2018
CELEBI GROUND HANDLING HOLD (prev. ‘Buy’)
Downgrade to a HOLD on valuation grounds
Downgrade to ‘HOLD’. We downgrade our recommendation for CLEBI Stock Data 24 October 2018 to a ‘HOLD’ on valuation grounds as our new target price at TRY62.5 Current price TRY58.1 offers 14% total return potential, including our TRY3.7/sh DPS forecast from 2018 earnings. The company has greatly delivered on our bullish Target price TRY62.50 expectations at the beginning of 2018 and even posted more lucrative DPS TRY3.7 financials than our estimates, especially in its foreign operations. Such a Total return 14% performance has also been reflected to the share price, marked by 112% Current Mcap TRY1,412mn / USD$247mn outperformance of the BIST 100 ytd,. We would consider further revisions to our valuation only once we become more convinced of the Bloomberg Ticker CLEBI TI outlook at the new airport. Capital (mn) 24 High / Low Price Range (12M) 60.15 / 29.21 Lower margins in Turkey... We expect deceleration in the company’s 3-m Average Daily Turnover ($ mn) 0.9 2019 volume growth in Turkey, especially in domestic lines, and foresee y/y lower margins due to weak volume growth, rising inflation, 2018’s Price Performance (%) 1M 3M 6M YtD high base effect and additional costs after relocation to the new airport. Meanwhile, our y/y flat yield assumption in EUR terms for intl’ flights and Return 18.4 52.3 65.1 73.9 c.17% inflation adjustment for domestic flights at a time when we revise Relative to BIST100 24.1 55.4 89.1 112.2 the company’s TRY-cash cost by c.40% also play a role in our 4.5pp lower margin forecasts for its Turkey operations. 70 Better reading in India... Our consolidated forecasts for Celebi’s 60 financials represent 3% EUR-revenue growth, despite 4% contraction in 50 Turkey thanks mainly to our more bullish forecasts for India on the back 40 of trailing financials. We foresee better readings for the rest of the 30 company’s foreign operations, and even for the company’s cargo 20 operations in Germany though concerns remain over its sustainability. 10 The new airport’s benefits unlikely to surface in the short-term... We 0
have long argued that Celebi’s volumes, and thus its revenue sources,
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01/18 05/18 would augment at the new airport, and that Celebi would be one of the 09/18 main beneficiaries of the new airport due to enlargement in available Price (TRY) Relative Price (TRY) slots to non-THY carriers. We still maintain our view, but in light of recent Source: Bloomberg, YKY Research developments, we think that achieving volume growth at the new airport capable of counterbalancing the heightened cost base would be quite demanding at the initial phase. This is because the bulk of the new airport’s initial capacity would remain allocated to THY and the number of newcomers, and/or higher frequencies of existing clients would be available only once operations fully settle, probably after the launch of the 2nd phase.
FX losses would not limit dividends. Despite its strong operational readings, we still expect Celebi to experience y/y earnings contraction in
2H18 due to FX losses over its c.EUR50mn short-position. However, we Mustafa Görkem Göker do not foresee any interruption in its high dividend payer status, and our [email protected] current DPS estimate of TRY3.7 represents a 6% dividend yield. +90 212 319 79 49
25 October 2018 – Celebi Ground Handling
Celebi - Summary Financials (*) Investment Thesis Celebi Ground Handling, founded in 1958 as the world’s first privately-owned ground handling company, is well positioned to benefit from a growing Turkish aviation sector. On the other hand, the company exercises both ground handling and cargo&warehouse operations in Hungary, India and Germny. We like, and welcome, the company’s growing exposure and improving volumes in India though the positive reflection on financials is gradually taking place. We do not expect a material change in the company’s both Hungary and Germany operations and expect a similar performance to 2018e. Last but not least, Celebi has always been well noted for its high dividend payer status and we see no major interruption on that front Yet, Capex needs at the time of moving IST operations to new airport might put a temporary pressure.
Potential catalysts and risks Potential catalysts include; i. higher volumes via new portfolio additions and/or sizeable agreements, ii. opening of the new airport in Istanbul that would permit more airlines to fly to the city. iii. weaker TRY suggesting margin gains Potential risks include; i. lower volumes for various reasons (i.e. bad weather, low tourist arrivals, loss of a client); ii. expansion of TGS to new domestic airports; iii. failure in concession renewals
Source: The Company, YKY Research (*) Our adj. EBITDA forecasts include 55% Celebi Nas’ profit and might differ from company’s calculation
25 October 2018 – Celebi Ground Handling
Table 1: Change in Forecasts
25 October 2018 – Celebi Ground Handling
VALUATION
We downgrade our ‘Buy’ recommendation for Celebi to a ‘Hold’ on valuation grounds. We revise upward our target price to TRY62.2/sh. from TRY51.0/sh., mainly on the back of our weaker TRY assumptions for domestic operations and higher contribution from abroad operations which are margin accretive for Celebi. However, we arrive at a lower price than our new macro assumptions suggest due firstly to our higher risk free rate assumption at 18.0% (previously 13%), our lower domestic volume assumptions, our concerns for heightening cost basis on inflation and new airport grounds limited such positive impact. Our new 12-month target share price of TRY62.2 (previously TRY51.0) represent 14% total return potential, including TRY3.7/sh. cash dividend from 2017e earnings (6% dividend yield).
We fully rely on DCF, while setting our target share price and refrain from international peer comparison due to the lack of a sufficient number of comparable peers.
Table 2: Valuation summary
Valuation Summary TRYmn Value Weight Target
DCF valuation 1,518 100% 1,521 12-Month Target Equity Value 1,521 Current market cap 1,412 12-Month Target Share Price 62.5 Current share price 58.1 Capital appreciation 8% DPS (2018e) 3.7 Dividend yield 6%
12M Total Return Potential 14%
Source: YKY Research
25 October 2018 – Celebi Ground Handling
Table 3: Celebi - DCF Valuation
Source: YKY Research
COMPANY UPDATE Equity (Rating Change) Research TURKEY 25 October 2018
PEGASUS AIRLINES BUY (prev. ‘Hold’)
Oversold – Upgrade to a BUY
Upgrading to ‘BUY’. We revise upward our ‘HOLD’ recommendation for Stock Data 24 October 2018 Pegasus to ‘BUY’ with a new target price of TRY 32.7/sh. (prev. Current price TRY21.7 TRY38.6/sh.), offering 54% upside potential. The stock has underperformed both the BIST 100 by c.20% ytd, lagging behind THY by Target price TRY32.70 c.35%. Although the company’s relatively high domestic market DPS TRY. exposure and higher fuel prices are valid reasons for such poor Total return 51% performance, further weakness would be overlooking the potential Current Mcap TRY2,217mn / USD$388mn positive catalysts. We expect the adverse impact of current domestic macro conditions on the company’s financial outlook to be less than Bloomberg Ticker PGSUS TI implied levels by current capacity mix thanks to higher focus on Capital (mn) 102 international lines, and higher demand at its hub Sabiha Gokcen Airport High / Low Price Range (12M) 37.34 / 21.30 (SAW) after the closure of Istanbul Ataturk Airport (IST). 3-m Average Daily Turnover ($ mn) 11.0 Higher international focus on lower TRY exposure. Pegasus currently Price Performance (%) 1M 3M 6M YtD allocates c.40% of its scheduled seat capacity to international (intl’) lines where it generates c.65% of its scheduled revenues. We expect a shift in Return -20.6 -27.3 -27.4 -37.0 the company’s focus to high margin intl’ lines to shield itself from Relative to BIST100 -16.8 -25.8 -16.8 -20.2 potential domestic market weakness. We believe that THY’s expected modest capacity growth in 2019, SAW’s easier accessibility than the new 40 airport and Pegasus’ relatively lower fares would be the key supporting 35 factors for intl’ load factors, while flat capacity would limit pressure on 30 domestic lines. Accordingly, we foresee intl’ flights comprising 45% of 25 seat capacity and claiming 76% of revenues in 2019e (vs. 42% and 70% respectively in 2018) and expect the adverse impact of a weak TRY on 20 the company’s financials to be less than its current FX mix suggests. 15 Margin contraction is almost inevitable on higher fuel bill. We were 10 already expecting a y/y margin contraction for 2019 because we find 5
current record-high margins unsustainable, while current macro
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05/18 09/18 headwinds, especially current rise in oil prices, further augment our Price (TRY) Relative Price (TRY) expectations. Accordingly, we expect 2.5pp y/y EBITDA margin Source: Bloomberg, YKY Research contraction for 2019, mostly on higher fuel bill assumption along with flat intl’ yields, a below-CPI increase in domestic fares and c.2pp lower load factor. However, we believe the risks to our forecasts to be on the upside, as we have not fully reflected the potential catalysts from higher intl’ flights into our model to be on the conservative side.
…but to be limited on lower ex-fuel CASK. We expect Pegasus’ EUR-CASK to decline by 4% in 2018E, despite 17% higher fuel-CASK thanks to 14% lower ex-fuel CASK. Our assumptions suggest further improvement in ex-fuel CASK in 2019e with a 2% y/y drop thanks mainly to lower operational leases, the weak TRY’s positive impact and efficiencies on higher aircraft utilization on longer haul flights.
Good entry point. On our estimates, which are all above the consensus for 2018 and 2019, Pegasus is trading at 5.1x 2019e adj. EV/EBITDAR and 7.3x P/E. We find current trading levels attractive for Mustafa Görkem Göker the mid and long-term, and expect a gradual re-rating in the stock, [email protected] especially after 1Q19 as we approach the summer season and the +90 212 319 79 49 benefits of greater intl’ exposure surface thereafter.
25 October 2018 – Pegasus Airlines
Pegasus Airlines - Summary Financials Investment Thesis Pegasus is the single true implementer of the low-cost airline business model in Turkey, whose main hub is Sabiha Gokcen (SAW). The sentiment to the company’s outlook has deteriorated after TRY sharply lost value against due to the company’s dependence on domestic market on the grounds that the current weak domestic demand would prevent the company from reflecting its heightened cost base to the air ticket fares and since the company’s functional currency is EUR, domestic yields would drop. However, we expect Pegasus to concentrate more on high margin intl’ flights and even there is limited capacity left in SAbiha Gokcen till the second rrunway would be operational, such new intl’ capacities are likely to be introduced from Ankara and İzmir. The weak trends in 2016 have fully disappeared and the initial expectations for the summer season by tourisim operators and government officials are promising and we argue that unless there would be sizeable downturn in foreign demand to/from Turkey, the pressure on margins stemming from weaker yields but higher jet fuel assumptions would be limited. Pegasus’ low unit costs would provide the company to offer more competitive prices, a tool whose importance would further surface at the time of move of IST operations to the new airport thanks to SAW’s better accessibility and SAW’s relative lower fares. Although we do not overlook the challenges in 2019, we would still find further depreciation in share price, after underperforming BIST- 100 by 22%, as unjustified with current financial outlook.
Potential catalysts and risks Potential catalysts include; i. strong traffic data indicating alive demand; ii. better than expected yields and margins; iii. further improvement in per pax ancillary income. Potential risks include; i. downturn in demand ii. Higher fuel prices iii. failure in cost containment efforts, particularly in high inflation environment. and iv. prolonged second runway construction at Source: The Company, YKY Research SAW.
25 October 2018 – Pegasus Airlines
Table 1: Change in Forecasts
25 October 2018 – Pegasus Airlines
VALUATION
We raise our ‘Hold’ recommendation to ‘Buy’ for Pegasus with a revised target price to TRY 32.7/sh. (prev. TRY 38.6/sh.), offering 51% upside potential.
Our downward target price revision mainly stemmed from our weaker TRY along with lower domestic demand assumptions but also due to change in our benchmark multiple in valuing the company from 6.0x adj. EV/EBITDAR to 5.5x on macro challenges and declining ROCE from 6.5% in 2018 to 3.5% in 2019.
If we continue to rely on 6.0x multiple, then our target price would have been 36% higher.
We opt not to rely on DCF when valuing an airline. This is because the cyclical nature of the aviation business has considerable attendant uncertainties that may severely threaten the accuracy and reliability of such a valuation, such as: (i) the utmost sensitivity of our DCF model to jet fuel prices and parity assumptions and (ii) low visibility regarding aircraft prices, which directly affects CAPEX assumptions.
Accordingly, we value Pegasus solely on a multiple basis and take a 5.5x 2019e adjusted EV/EBITDAR (previously 6.0x for 2018e) as the benchmark and fair multiple in valuing the company, as we apply for Turkish Airlines
Table 2: Valuation summary
Multiple Valuation 2019e EV/EBITDAR TRY Target Adj. EV/EBITDAR 5.00 5.50 5.75 6.00 6.25 2019e EBITDAR 2,417 2,417 2,417 2,417 2,417 Fair EV 12,086 13,295 13,899 14,504 15,108 2019e Adj. Net Debt 11,414 11,414 11,414 11,414 11,414 Pre-Delivery Payments 1,450 1,450 1,450 1,450 1,450 Value of Participations 22 22 22 22 22 Fair Equity Value 2,144 3,353 3,957 4,562 5,166 Target Price (TRY) 20.9 32.7 38.6 44.6 50.5 Current Price (TRY) 21.7 21.7 21.7 21.7 21.7 Upside -4% 51% 78% 106% 133%
COMPANY UPDATE
Equity TURKEY Research 25 October 2018
TAV AIRPORTS HOLDING HOLD (prev. ‘Hold’) Overshadowed by uncertainties of the new airport
‘Hold’ maintained. We revise downward our 12M target price for TAVHL Stock Data 24 October 2018 by 18% to EUR4.5/sh. from EUR 5.5/sh. due mainly to (i) the change in Current price TRY26.8 our EUR-risk free rate from 5% to 7%, (ii) adjusting our net debt forecast with the loan provided from ADP to finance the Antalya acquisition and Target price TRY28.510 (iii) our new macro assumptions. Our new target price offers 15% total DPS TRY2.3 return, including a 6% 2018E dividend yield, and we maintain our ‘HOLD’ Total return 15% recommendation. TAV still has not received a response from the State Current Mcap TRY9,736mn / USD$1,703mn Airports Authority regarding its compensation for early closure of IST, and we attribute the weakness in share price, despite its improving Bloomberg Ticker TAVHL TI financials, to uncertainty on that front, which also overshadowed Capital (mn) 363 positives in other airports. Thus, we do not expect positives to be priced High / Low Price Range (12M) 32.96 / 16.95 in until further clarity is reached. 3-m Average Daily Turnover ($ mn) 9.6 Lower growth with higher margins in 2018… TAV has enjoyed rising Price Performance (%) 1M 3M 6M YtD air travel demand to/from Turkey and also in its abroad operations ytd; a 15% y/y increase in direct intl’ pax traffic at IST was particularly lucrative. Return -10.6 -1.7 13.0 27.2 The company’s revenue growth lagged its volume growth due mainly to a Relative to BIST100 -6.2 0.3 29.4 55.4 lower EUR-equivalent of TRY-based revenues, which also adversely impacts locals’ duty free shopping appetite. Yet, since TRY claims larger 35 stake in cost base, the company’s operating margins are ultimately 30 positively impacted from TRY weakening. We foresee 6.7pp EBITDA margin improvement in 2018 on 3% higher revenues. Among foreign 25 operations, the most promising readings were in Tunisia where TAV 20 expanded its revenues by 36% y/y in 9M18 and posted positive EBITDA. 15 Meanwhile, despite relative normalization in Georgia following lower Iranian arrivals, growth remained high and Georgia remains the largest 10 contributor after IST to our NAV. 5
…to be followed by slightly higher revenue growth and flat margins
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05/18 09/18 in 2019. We expect TAV to post EUR1.2bn consolidated revenues and Price (TRY) Relative Price (TRY) c.EUR620mn EBITDA in 2019 representing 4% y/y revenue growth with Source: Bloomberg, YKY Research a flat EBITDA margin of 52%, provided that IST becomes operational by the end of 2019. We expect the expected margin losses on the Havas front due to the new airport and relative slowdown in new capacities to be compensated mainly by Georgia.
What if IST closes by end-2018? It is hard to fully assess the impact of the loss of IST on TAV’s financials because we do not exactly know certain subsidiaries’ Istanbul dependence. Yet, based on certain assumptions, we would expect our top-line forecast of EUR1.2bn in 2019 to drop to c.EUR565mn, and our EBITDA to c.EUR310mn. The critical question at this point is how, and how much, TAV would be compensated for IST’s early closure. We expect TAV Istanbul itself, excluding ATU or other subsidiaries, to generate a total of c.EUR550- 600mn EBITDA in 2019 and 2020. Since TAV Istanbul is already in a net cash position, thus no material financial expenses would be incurred; the bulk of EBITDA would be reflected to pre-tax income. Yet, we refrain from providing any point estimate for the potential size of the Mustafa Görkem Göker compensation package due to the lack of information for the rest of the [email protected] portfolio to be impacted by Istanbul airport’s closure +90 212 319 79 49
25 October 2018 – TAV Airports Holding
TAVHL - Summary Financials (*) Investment Thesis TAV Airports Holding, founded in 1997, is Turkey's leading airport terminal operator with a foothold at 14 airports in five countries, namely Turkey, Georgia, Macedonia, Tunisia, and Saudi Arabia. The Company tries to capture all revenue generating activities at an airport (e.g. duty free, catering, ground handling) through its subsidiaries. TAV’s revenues, mostly in hard currencies, are dependent mainly on passenger traffic while costs, mostly denominated in TRY, are mostly fixed in nature and relatively less dependent on passengers, providing the company an operational leverage advantage. On the flip side, at times volumes are down, like 2016, the company’s margins are adversely affected immediately. On the other hand, since the company is TRY short on the operational front (i.e. TRY costs > TRY revenues), weaker TRY enhances its margins. The uncertainty about the compensation payment the company in exchange for early closure of IST is still not clarified and this would continue to deteriorate the sentiment towards to the stock. Thus, we would welcome the hearing the outcome of ongoing negotiation talks with state. We do not expect any new contribution to the portfolio nor any material CAPEX in the short-term, thus TAV might increase its dividend payout starting from 2018e. Potential catalysts and risks Potential catalysts include; i. new additions to the portfolio and/or sizeable tenders, ii. late opening of the new Istanbul airport. iii. low oil prices triggering higher air passenger traffic iv. management’s dedication to dividend distribution Potential risks include; i. less than expected compensation for IST ii. downturn in passenger traffic; iii. failure in concession renewals and/or new additions; iv. lower duty free spending
Source: The Company, YKY Research (*) (*) Adjusted financials: guaranteed passenger fees for Ankara Esenboga which are excluded from income statement due to IFRIC are added back to revenues
25 October 2018 – TAV Airports Holding
Table 1: Change in Forecasts
Source: TAV, YKY Research (*) all numbers are IFRIC 12 adjusted.
25 October 2018 – TAV Airports Holding
VALUATION
We revise downward our 12-month target share price for TAV to EUR4.5/sh. from EUR5.5/sh. due mainly to change in our EUR-risk free rate from 5% to 7% as well as our weaker revenue forecast in the near-term on macro challenges in domestic market. Additionally, we adjust our end-2018 net debt with the loan provided from main shareholder ADP amounting to EUR304mn to finance Antalya acquisition.
We fine tune our estimates but the main difference is the inclusion of Antalya airport to our estimates via equity pick up which played an important role behind our 7% higher adj. EBITDA forecast for 2019 despite 5% lower consolidated revenues. Lastly, we expect the company to pay a TRY2.3/sh. cash dividend from its 2018e earnings in 2019 translating into 8.0% dividend yield. Accordingly, we calculate 9% total return potential for the stock in the next 12M, which merits a ‘Hold’ recommendation according to YKY’s rating scheme.
Source: YKY Research
COMPANY UPDATE
Equity TURKEY Research 25 Oct 2018
TURKISH AIRLINES BUY (previously BUY)
Ready to tackle challenges
‘BUY’ maintained. We maintain our ‘BUY’ recommendation for Stock Data 24 October 2018 Turkish Airlines (THY) with a new 12M target share price of TRY 20.60 (prev. TRY19.5/sh.), offering 33% total return potential. We Current price TRY15.5 attribute the weakness in share price over the past three months to Target price TRY20.60 uncertainties related to the move of Istanbul Ataturk hub operations DPS TRY. to the new airport, and increasing oil prices. We also consider both as Total return 33% the foremost risks and expect relatively weaker results in 4Q18-1Q19 financials. However, we refrain from adopting a negative stance Current Mcap TRY21,445mn / USD$3,751mn solely on potential short-term weakness and still favor the stock on Bloomberg Ticker THYAO TI the back of its undemanding valuation (5.3x 2019e adj. EV/EBITDAR) Capital (mn) 1,380 and continue to find its long-term story appealing. High / Low Price Range (12M) 19.77 / 9.79 Concerns are fair… We find concerns over a potential spike in the 3-m Average Daily Turnover ($ mn) 191.1 company’s cost basis due to the relocation of operations to the new airport fair, as there is much uncertainty on that front, and the Price Performance (%) 1M 3M 6M YtD company is likely to be incurring unnecessary costs such as Return -16.2 -9.3 -9.0 -1.0 concurrent use of both airports for its cargo operations or catering business, at least in the initial phase, experiencing operational Relative to BIST100 -12.1 -7.4 4.2 23.2 redundancies such as planning flight crew on top of various one-off expenses. Additionally, we also agree that high CPI would re- 25 necessitate the company to adjust its TRY-based costs, especially 20 pilot wages, similar to the interim adjustment in June. Accordingly, such concerns turned out to be the underlying reasons behind our 15 conservative stance in formulating our assumptions, marked by a 4.5pp y/y lower EBITDA margin for 2019. 10
…but we should not overlook the positives. Having shared the 5 market's concerns regarding the new airport and cost basis, and
reflecting them to our forecasts, we stress that a further level of 0
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01/18 05/18 deterioration in financials and/or correction in share price on the 09/18 same grounds at current trading levels would be unwarranted. This is Price (TRY) Relative Price (TRY) because (i) the company would introduce limited capacity in 2019, which should limit any decline in current record high load factors, and as current traffic results suggest no weakness, (ii) being TRY-short on the operational front enables the company to enjoy margin expansion at times of weak TRY and reduce inflation pressure on its CASK, and 2019 should be no different, (iii) increasing fuel prices will Source: Bloomberg, YKY Research lower excess capacity in the sector, offering a relatively more favorable pricing environment supportive of fuel surcharges and, (iv) sizeable improvement in cargo revenues, which now claim 13% of total, vs. less than 10% five years ago
Beware of new ventures. We were surprised by THY’s management not fully dismissing claims that the company was interested in acquiring a stake in Sabiha Gokcen Airport at their latest conference call. We see no single rational reason behind such a potential venture, but many contradictions for THY, such as being the terminal operator of its largest domestic airline competitor (i.e. Pegasus) and at the same time, being a competitor to its hub operations’ terminal Mustafa Görkem Göker operator (i.e. IGA). We would review our current positive stance an [email protected] our understanding of THY’s strategy in the event that management +90 212 319 79 49 allocated company resources to such a venture.
25 October 2018 – Turkish Airlines
Turkish Airlines - Summary Financials Investment Thesis Turkish Airlines, founded in 1933, is the Republic of Turkey's national flag carrier operating with a fleet of 336 aircraft as of end-3Q18 flying to >300 destinations and targeting to be among the 10 largest airlines in the world with a strategy of greater focus on transfer passengers by utilizing Istanbul’s location advantage. The company’s faster than global average growth in the last decade was interrupted in 2016 due mainly to geopolitical risks and security concerns and the company has not been aggressive since then and we expect 2019 will be a similar year from that perspective, especially due to move of its IST hub operations to the new airport. We admit that great uncertainties on that front is a big worrisome and threaten our forecasts. Yet, such potential deterioration have already been reflected in the share price in our view, and further decline is questionable amidst the company is very well positioned to benefit from weaker TRY and ongoing strong international traffic to Turkey. Potential catalysts and risks Potential catalysts include; i. strong traffic data indicating robust demand, especially improving load factors; ii. lower than expected erosion on yields and better margins; iii. stable political environment in Turkey's proximity; Potential risks include; i. any stake purchase in SAW ii. lower demand triggering lower load factors, especially at the time of move of IST operations iii. higher than expected erosion on passenger revenue yields; iv. adverse oil price and parity movements.
Source: The Company, YKY Research
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25 October 2018 – Turkish Airlines
Table 1. Change in Forecasts
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25 October 2018 – Turkish Airlines
VALUATION
We increase our target share price for THY to TRY21.2/share from TRY19.5/share despite our lowered target benchmark multiple in valuing the company from 6.0x adj. EV/EBITDAR to 5.5x adj. EV/EBITDAR in order to factor in macro challenges and relative weakness in its ROCE in 2019 vs. 2018 on higher cost base. The foremost factors behind our higher target share price are (i) stronger operational results, especially on international lines, (ii) better than expected yields in trailing financials, (iii) weaker TRY which is margin accretive and, (iv) slower capacity growth than previously anticipated. Meanwhile, additional costs to be incurred during the move of operations to the new airport, TRY inflation adjustment and last but not least, the higher oil prices were the main reasons which partially offset the positive impact of our higher operational forecasts.
We set our target price based on target 2019e adj. EV/EBITDAR multiple of 5.5x (previously 6.0x). We have not relied on DCF because the cyclical nature of the aviation business has considerable attendant uncertainties that may severely distort the accuracy and reliability of a DCF valuation, such as: (i) the utmost sensitivity of our DCF model to jet fuel prices and parity assumptions and (ii) low visibility regarding aircraft prices, which directly affect CAPEX assumptions.
We deliberately incorporate an adjusted EV/EBITDAR multiple, rather than EV/EBITDA in order to eliminate the company’s financing decisions from its operating performance, where R stands for operational lease expenses. Please note that we also added our off-balance sheet operational lease debt expectation to the company’s net debt in the calculation of EV.
Table 1. Valuation summary
Multiple Valuation 2019e EV/EBITDAR TRY Target Adj. EV/EBITDAR 5.25 5.50 5.75 6.00 6.25 2019e EBITDAR 17,296 17,296 17,296 17,296 17,296 Fair EV 90,806 95,130 99,454 103,778 108,102 Adj. Net Debt 68,488 68,488 68,488 68,488 68,488 On B/S Net Debt 58,206 58,206 58,206 58,206 58,206 Off B/S Operational Lease Debt 15,036 15,036 15,036 15,036 15,036 Pre-Delivery Payments 4,753 4,753 4,753 4,753 4,753 Value of Participations (w/50% discount) 1,788 1,788 1,788 1,788 1,788 Fair Equity Value 24,106 28,430 32,754 37,078 41,402 Target Price (TRY) 17.40 20.60 23.70 26.80 30.00 Current Price (TRY) 15.5 15.5 15.5 15.5 15.5 Upside 12% 33% 53% 72% 93%
Source: YKY Research
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