Turkish Airlines Research Report: Turkey’s Escalating Crisis to Hurt Growth & Share Price

13 August 2018, Turkey – In the last 12 years, Turkish Airlines (THYAO:TI) has grown into one of the world’s largest airlines with 5 times the number of passengers carried and a target to further increase its aircraft fleet by nearly 50% in the next 5 years to 475 planes by 2023 from 325 planes (averaging 8.1 years old) currently. Turkish Airlines flies to more countries (122 currently) than any other airline in the world, helped by its strategic hub location in Istanbul.

Just when Turkish Airlines has recently turned around with a strong profit performance in 2Q18 and more bullish management guidance for the full year, Turkey’s escalating crisis is likely to hamper Turkish Airlines’ near term growth prospects, driving its share price to correct, in our view.

Although Turkish Airlines’ current valuations are undemanding at 7.0x P/E and 0.94x P/B, the stock is still susceptible to a correction as Turkey’s crisis escalates and investors trim their exposure to Turkey’s stock market. There is still a 66% downside to Turkish Airlines’ historical trough P/B and P/E valuations, in the worst case scenario.

Turns profitable in 2Q18 and management guidance is bullish

Turkish Airlines has just reported strong financial results for 2Q18 with net profit of US$127 million and net profit margin of 4.0%, EBITDAR margin of 23.6%, turning around from losses in 1Q18 and 2Q17.

Management has recently raised its 2018 targets for Turkish Airlines to carry 75 million passengers (56% on international routes + 44% on domestic routes), +8.7% y/y, 1.3 million tonnes of air cargo (+21% y/y) and generate US$12.5 billion sales revenue (+14% y/y) and 25% consolidated EBITDAR margin (-2.5ppts y/y) in 2018.

Turkish Airlines has also pragmatically hedged 50% of its 2H18 and 22% of its 2019 fuel requirements. In July 2018, Turkish Airlines’ passenger load factor rose 1.5ppts y/y to 85.3%, its highest July load factor in history) while its cargo volume carried surged 20% y/y.

However, flag carrier Turkish Airlines’ growth could be hampered by its home country Turkey’s escalating crisis and the stock is still susceptible to a correction as investors trim their exposure to Turkey, in our view.

Although Turkish Airlines’ well-diversified traffic flows and revenue base will help mitigate the impact…

As a major hub-and-spoke carrier with significant international connecting traffic and a key member of the Star Alliance, Turkish Airlines’ revenue is well-diversified which will help to mitigate the impact of Turkey’s escalating crisis at its home base.

Transfer passengers constitute 42% of Turkish Airlines’ total passenger traffic, helped by the carrier’s high connectivity. In addition, 11% of Turkish Airlines’ passenger revenue is driven by domestic routes and this segment tends to be relatively more defensive during downturns.

Chart: Turkish Airlines Passenger Breakdown by Transfer Type

Turkish Airlines Passenger Breakdown by Transfer Type

…the flag carrier will not be immune to Turkey’s escalating crisis as business traffic and demand in the Americas route region will be hurt

However, Turkish Airlines will not be immune to Turkey’s escalating crisis. We expect its travel demand to be negatively impacted by the rift between home country Turkey and the United States, the rapidly depreciating Turkish Lira and weakening macroeconomic conditions.

Firstly, 22% of Turkish Airlines’ passenger revenue is derived from business class which is highly leveraged to any weakening in the macroeconomic environment and financial system.

In addition, the Americas route region contributes 14% of Turkish Airlines’ total passenger and cargo revenue which will be hurt by the escalating Turkey-US tensions.

Chart: Turkish Airlines Total Passenger & Cargo Revenue by Geography (1H18)

Turkish Airlines Total Passenger & Cargo Revenue by Geography (1H18)

Cargo business to hurt if Turkey-US trade tensions escalate

The US trade tariffs have not affected air freight demand directly so far but this could change if the trade rift is  broadened to include other commodities that are transported by air. Cargo contributes 13% of Turkish Airlines’ total revenueand the carrier, which has a global air cargo market share of 2.4%, is targeting to become one of the world’s largest air cargo carriers.

Rapidly depreciating Turkish Lira is negative for Turkish Airlines

The rapid depreciation of the Turkish Lira will also have a negative impact on Turkish Airlines. Turkish Airlines has a currency hedging policy in place, using a gradually decreasing layered hedging strategy over 24 months. However, the currency hedges will not completely offset the impact of the significant Turkish Lira currency volatility on Turkish Airlines, in our view.

Moreover, all of Turkish Airlines’ finance lease liabilities are denominated in foreign currencies. These amount to US$1.0 billion in yearly debt service payments and the total foreign debt amounts to US$7.7 billion with maturity of 10 to 12 years.

Chart: Turkish Airlines Currency Hedging

Turkish Airlines Currency Hedging

Chart: Turkish Airlines Revenue Breakdown By Currency

Turkish Airlines Revenue Breakdown By Currency

Chart: Turkish Airlines Expenses Breakdown By Currency

Turkish Airlines Expenses Breakdown By Currency

Aircraft and airport investments and financing to become more challenging for Turkish Airlines

The weakening Turkish Lira will also make it more challenging for Turkish Airlines, which has 220 aircraft on order, to finance its future aircraft capex. The broadening contagion in the financial system will significantly increase Turkish Airlines’ financing challenges as well.

As such, Turkish Airlines’ plans to invest in airports, including its rumoured plans to acquire a stake in Istanbul’s Sabiha Gokcen International Airport from Malaysia Airports Holdings (MAHB:MK) and to finance Istanbul’s third airport, are likely to be delayed, in our view.

Share price to correct notwithstanding Turkish Airlines’ current undemanding valuations

Although Turkish Airlines’ current valuations are undemanding at 7.0x P/E and 0.94x Price/Book, the stock is still susceptible to a correction as Turkey’s crisis escalates and investors trim their exposure to Turkey’s stock market, in our view. There is still a 66% downside to Turkish Airlines’ historical trough P/B and P/E valuations.

Chart: Turkish Airlines Price/Book Valuation Range (2008 to 2018)

Turkish Airlines Price/Book Valuation Range (2008 to 2018)

Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

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