Turk Hava Yollari AO
IST:THYAO.E
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Ladies and gentlemen, welcome to the Turkish Airlines Q2 2018 Results Conference Call and Webcast. Today's speakers are Mr. Ilker Ayci, Chairman of the Board and the Executive Committee; and Mr. Murat Seker, Chief Financial Officer. Dear speakers, the floor is yours.
Thank you so much, Melanie. It's a great pleasure to have this opportunity again. Dear all, welcome to our second quarter financial results presentation. As we have iteratively expressed, 2017 was a year of comeback for Turkish Airlines. Total revenues grew by 12%. Number of passengers grew by 9% and EBITDAR margin grew by 11 percentage point in 2017. In the first half of 2018, we continued to observe strong performance in both financial and traffic figures. Total revenue increased by almost 30% year-over-year to nearly $6 billion. Profit from main operations increased by almost 14x compared to the same period of last year and reached around USD 260 million. In the first half of the year, total number of passengers was up around 18%, 1-8, 18%, and exceeded 35 million level for the first time, while the ex-fuel CASK increased about 6% and the total CASK increased by 11%, [indiscernible] was up by around 16% in the first half of the year. EBITDAR margin increased by almost 1.5 percentage point in the first half, while the absolute EBITDAR value increased by around 30%.
As a result of strong first half, we revised the year-end guidance. We revised the year-end passenger numbers from 74 million to 75 million and load factor to 81%. Unconsolidated revenue expectation was raised by $700 million to $12.5 billion, and unconsolidated EBITDAR margin was raised by 1 percentage point to 25%.
There are several factors behind the successful first half. Most important factors are the strong demand, continuing capacity discipline and the cost management initiatives. As you can see on the slide, the number of the tourists arrive in Turkey has been steadily increasing since 2016. In the first half of 2018, we observed a 30% increase and expect this number to reach 40 million tourists at the end of the 2018. This means a 23% increase compared to the last year and 57% increase compared to 2016. The number of international passengers, excluding international transit passengers, surged by 16% year-over-year in 2017 while this increase was 22% in the first half of 2018. When we have a closer look at the point-to-point passenger growth, we note that -- we note the growth from Europe by 25% and from emerging Asia by 61%. This growth in international passengers helped achieving higher yields with double-digit growth in the first half of the year. The strong demand also enabled us to transfer part of the increase in jet fuel prices to the ticket prices.
I would like to briefly update you about the move to the new airport. We are doing all the necessary preparations in order to be ready in the new airport. We are working in cooperation with all related parties about the move. In the meantime, the construction of our buildings are continuing as scheduled. We have accumulated the necessary financing for the completion of this project. With this new airport, there will be a lot of new opportunities for us to expand our network.
With these remarks, I will now leave the floor to Mr. Murat Seker to continue with the presentation. Yes, Murat, the floor is yours.
Thank you very much, Mr. Chairman. I will continue with Slide 7. And let me start with providing some traffic figures. Turkish Airlines keeps taking a good share from the growth in the tourism sector in Turkey. During the first half of the year, our total passengers grew by 17%, almost 18%, reaching almost 36 million passengers, which corresponds to about a 20% increase in domestic passengers and a 16% increase in international passengers. Thanks to the active capacity management and the strong demand, total load factor improved by about 4.4 points to 80%. Especially, international routes made a significant contribution to total load factor improvement. According to our published June traffic results, we have recorded the highest load factor in Turkish Airlines history for the first 6 months.
Let's now have a look at the passenger breakdown. International direct passengers, which is a high-yield segment, increased by 22% during this first half. The number of transfer passengers went up by 11% compared to the first half of the last year's. When we come to the international passenger breakdown by geography, in Europe, as our Chairman stated, we see a strong improvement. As you remember, last year, we lost some European passengers. But this year, we can easily see the demand is coming back very strongly. Contribution of African passengers also increased during the same period. In the lower section, as I mentioned earlier, we see a noticeable shift from international transit passengers to international direct passengers. Turkish lira depreciation makes Turkey more attractive for tourists. Therefore, we can expect improvement in international direct passengers segment to continue to pick up pace in the upcoming months.
As we expand our fleet, we choose to invest in new generation and environmental friendly aircraft. In the second half of the year, we will have 13 new deliveries, including 10 narrowbodies and 3 777 freighters concluding to '18 with 328 aircraft. As you see the deliveries in the bottom row, we expect to reach 475 aircraft by the end of 2023.
When we look at the cargo operation, regarding our cargo business, we see the continuation of our strong demand growth and capacity growth. Our total tonnage of cargo carried increased by 28% and reached 661,000 tons and the revenues went up by 35% in the first half. Currently, we have 1.2 million tons capacity available in the existing terminal at Atatürk airport, which is going to increase to 2 million tons in the first phase of the new airport and then will incrementally increase to 3.5 million tons with additional phases of the new airport construction.
Looking at the financial data, as you would recall, in 2017, we had all-time high revenue both on passenger side and on cargo side. For the first 6 months, Passenger revenue increased by almost 30% and Cargo revenues increased by 35%. These results show the strength of our financial capacities and how we benefited from strong passenger and Cargo demand on the back of a favorable domestic and international tailwinds, such as the increasing tourist arrivals to Turkey. In the second quarter, despite the high fuel prices, 21.4% increase in revenues was more than enough to offset 17.5% increase in costs resulting in almost 15% increase in profit from main operations. Together with the profitable first quarter, we succeeded at almost 14-fold increase in profit from main operations during the first half.
Net income grew by $475 million in the first half. As stated in our financial audit report, the unrealized foreign exchange differences arising from the revaluation of financial lease liabilities are now recognized in other comprehensive income under equity. We will shed some more light about this issue in the coming slides.
In the first half of '18, we reached almost 22% EBITDAR margin, which is a record level for the first half of the year. Thanks to the strong traffic results, we generated almost $1.3 billion of EBITDAR, which is higher than the 2015 level of $924 million.
Now let's look at the revenue breakdown. In the left chart, we see the breakdown by business type. And you can see here as in the past, majority of the revenue comes from the passenger revenues, and second-biggest component is the cargo with 14 -- 13.2%. The positive environment in tourism and aviation sector is stimulating both passenger and cargo demand. The chart on the right gives the geographic breakdown. Well diversified revenue generation capability continues to help the possible regional volatilities. 89% of the revenues in the first half are generated from outside of Turkey with the biggest contribution coming from Europe followed by Far East regions. We managed to increase the share of Africa and Europe in this period. Europe, with more than 110 destinations we fly to, continue to be an important region for us. During the last call, we mentioned the positive news from European tour operators regarding the reservations to Turkey. We actually witnessed this growth in the second quarter.
Revenue yield and RASK development was very strong especially in the second quarter. RASK increased double digits both in the second quarter and the first half of 2018. When we look at the second quarter results, yields and the RASK both increased by 11%, which is a direct sign of better demand and pricing environment.
For the first half of the year, passenger yields increased by 11% and RASK grew by more than 15%, which is quite strong when we look compared with the ASK growth of 9%. Shifts in the passenger mix towards high-yielding point-to-point traffic due to increased tourist arrivals to Turkey as well as the increasing load factor were substantially important for this growth. Direct passenger traffic yields is about [ 20% to ] 40%, higher than international transfer passenger yields.
Significant revenue increase of Turkish Cargo also supported RASK growth. We look at the yield development across the region, we see the strong improvement in Europe revenues and the growth of double digit were present in all regions in the first half. 23% RASK growth seen in Europe has been impressive and it indicated that the recovery on demand is continuing. Despite of the depreciation of Turkish lira, domestic RASK continued to grow mildly. Revenue development in the second quarter, and here on the graph we can see the drivers. Main driver has been passenger RASK growth of more than 15% and a 5% contribution came from the capacity growth and the load factors of around 80%. On the Cargo side, improvements of our Cargo business segment again contributed to revenue development as in the previous quarters.
When we look at the revenue development of the first half, we see 17% contribution from passenger RASK and 9% capacity growth and almost 5 percentage point increase in the load factor. On the second quarter, currency movements positively affected revenue due to 12% euro appreciation against dollar when euro-based revenues make about 27% of our total revenues. 35% Cargo revenue growth is also another important driver of the total revenue development in the first half. When we look at the cost side, our total expenses increased by almost 18% in the second quarter, which fuel expenses was a big driver of this increase. Rising fuel prices continue to put significant pressure on the cost base. As of second quarter of the year, fuel expenses represented almost 32% of the total costs, up from 28% a year earlier. But thanks to our low cost base and well working hedge mechanism, we were able to dilute impact of this increase in fuel prices partially. Apart from the fuel cost, another substantial increase came from the maintenance front. There are 2 main drivers for this. First 1 is the low cost base of '17. Remember last year, in the second quarter of '17, unit maintenance cost dropped by 17% as there were deviations in the maintenance plans of spare engines and aircraft to the last quarter of '17, which caused a significant increase in the maintenance cost of the last quarter. However, when we look at the year-on-year, last year, the maintenance increase was within our projections. And this year, despite of this increase in the second quarter, we expect to finish the year within our projections. When we look at the CASK breakdown, our -- on per ASK basis, our costs continue to be among the lowest in the industry. Even the rising fuel prices in the second quarter affected the cost base negatively. The cost management discipline allows us to withstand the pressure and increase our profitability. Ex-fuel CASK increased by 6% levels in the second quarter. Limited increase in the aircraft ownership costs stemmed from few aircraft entries. Part of the increase in sales and marketing expenses were due to online sales, increase in online sales, as the commission rates charged by payment service providers increased in the first half. We expect ex-fuel [ CASK ] to stay stable in the second half of the year and finish the year with 3% to 5% growth in ex-fuel CASK as we have guided at the beginning of the year. And as you would note in the guidance that we provided this morning, we did not revise the CASK guidance.
And the graph here also shows the -- our low cost basis. When you compare with the peers, we have a significantly lower CASK as compared to our peers. When you look at the profits, operating profit growth is 15% in the second quarter. A main driver of this growth is the improving unit revenue. However, increase in the unit operating costs, especially fuel, negatively affected operating margin. When we look at the first half evaluation, you can see the operating profit development, which has the same positive and negative drivers as the second quarter, we're pretty much in the same sense. Currency volatility positively affected both revenue and cost [indiscernible] due to Turkish lira based operating costs and euro revenues portion on the revenue. On the hedging side, about half of our revenue and expenses are in U.S. dollars. And as seen in the distribution, we are long in euros and short in Turkish liras. Because of this mismatch, we hedged our short position with long euro position. We make bulk trades for the next 24 months, and our target hedge ratio is 30% for Turkish lira and between 25% to 30% for U.S. dollars.
On the fuel side, we used swaps and option based structures as we used to use, our maximum hedge ratio is about 60% and maximum tenor is continuing to be 24 months. As of the end of June, we had around 21 million barrels hedged position. 11 million barrel of the total position belongs to period of the last 2 quarters of this year.
Aircraft financing side. As we've stated earlier, we have plan to include only 13 new aircraft this year. Our fleet consists of 325 aircraft currently. 200 of these are financial leased and 38 of them are either operational [ or with lease ]. Based on this structure, our total amount of financial lease liabilities is $7.7 billion while the total amount of operational lease liabilities is $1.8 billion. And as you can see on the right chart, about 76% of these finances are with fixed interest rates. Hence, the impact of possible higher global interest rates on our total debt is expected to have a limited impact. I would also like to make a quick note here. We started to implement a new FX calculation method since the first quarter of this year. Our euro and CHF financial lease obligations are defined as nonfinancial derivative instruments, while 40% of our Japanese yen financial lease obligations are defined as nonfinancial derivative instruments. According to this new method, unrealized foreign exchange rate differences arising from the financial lease liabilities in Japanese yen, Swiss franc and euro are recognized in other comprehensive income. With this method, net income volatility is expected to be reduced. Change in the net income will be offset by the change in fair value losses on hedging instruments entered into for cash flow hedge and thus, there will be no change in the total comprehensive income. I know that a lot of our analysts have been asking us about this particular issue, so we wanted to put some more light regarding to that.
Lastly, I want to touch upon July traffic results, which we announced this morning. Traffic results shows a strong second half, indicates a strong second half, actually. During January, July, increase in demand on total number of passengers was 13% and 15%, respectively, over the same period of last year. Total number of passengers reached to 43 million in July. Load factor continued to improve by 4 percentage points and reached to 81%. Excluding international transfer passengers, number of international passengers went up by 18%. Cargo, mail carried during the 7 months continued to increase by 26% and reached 779,000 tons.
With this last note, I conclude the presentation. And now we might open -- continue with the question-and-answer session.
[Operator Instructions]
As before I will read the question and we'll answer them. What is the impact of oil price increase? And are you able to reflect some part of this increase on the ticket prices?
In the start of the 2018, fuel costs increased by $440 million year-over-year. We are able to increase the fuel surcharge more than previous years, which covers almost half of the increase in the fuel price increase before hedge.
And how do you -- how do your forward looking look like for the third quarter and beyond?
It is all positive for the second half of the year. For August, September and October, which we relatively have higher visibility, there is around 2 percentage point increase in overall international load factors.
A question by [indiscernible]. First half '18 EBITDAR margin is 21.5%, and you guided 25% for the year-end. For second half of the year, do we expect 27% to 28% EBITDAR margin?
Our EBITDAR margin expectation for the second half of the year is approximately, yes, 28%.
This is a question that we get a lot about our recent engagement with Emlak Konut. Regarding to the real estate project with Emlak Konut, what is the partnership model? Do you plan to make more CapEx? What sort of cash flow will you have?
Turkish Airlines owns 50% of the project including the land. Other than the initial CapEx of around $75 million, we do not plan to have other CapEx. We plan to collect down payments and installments prior to the cash outflows. The project will bring a reasonable profit for Turkish Airlines and we'll be able to accommodate affordable housing for our staff.
Can you give some more detail about the ZTO deal and the rationale behind this partnership?
Yes, with pleasure. Along with booming e-commerce volumes, the worldwide express carrier industry is showing outstanding growth rates. In 2016, this industry had around $260 billion revenue realization. And it is now expected to reach $340 billion in 2023 -- in 2020. This partnership is a big opportunity for us to enter the global e-commerce market. The joint venture is expected to take place around the world's largest integrators. In 5 years' time, we expect the JV to generate over $2 billion of revenue. The cooperation between the 3 partners will form synergy by combining strong core competences and integrating key resources. It will contribute to the progress in the areas of global express delivery, warehousing and cargo freight.
The next question is from Osman Memisoglu from Bank of America. Can you please comment on the FX, reversal of FX gains under other operating income in first quarter to FX losses in the second quarter? Is there any strategy to limit these losses in an environment of continuing Turkish lira depreciation? The reversal of FX gains under operating income in the first quarter to FX losses in second quarter is corresponding effect of the obvious dollar appreciation against other currencies. In the -- overall, in the second -- in the first half, we had about $49 million losses. We had a strategic act on this but usually, it is like also it was on the slide, when we look at our gains in other currencies, we look at the correlations with dollar and euro. Usually, the currencies that are correlated with dollars, we do follow them on our cash flow statements closely. And also, regarding these FX losses from operations, as we hedging the euro against dollar and then Turkish lira against dollar -- against euro, we compensate part of these trade losses as financial derivative income. The next question is on Turkish lira depreciation. What is the impact of depreciated Turkish lira on international demand and overall profitability?
The depreciation of Turkish lira has very limited impact on profitability, as 14% of our revenues are in Turkish lira, about 26% of our expenses are in this currency. Hence, the overall impact is small. On the international demand side, potential in appetite to travel abroad by Turkey citizens is much smaller than the international passengers who want to travel to Turkey. Hence, the overall impact on, we observed, on demand since the beginning of the year is positive and strong. Our [indiscernible] increased by 15% in the first half of 2018.
There is a question about the -- our airport terminal. Considering that the cargo terminal in [indiscernible] will not be ready to operate in 2019 in the new airport, how much extra cost should you bear next year? We have announced -- our Chairman has announced earlier that the total cost of the construction will be around $650 million to $700 million. And for -- to be ready for the operation, there will be satellite campuses -- satellite buildings will be constructed. The cost will be significantly low as compared to our main site. Plus these satellite constructions will not -- will be a part of the actual buildings anyway, so it's not going to be an additional cost. It will be -- they be part of the actual cost of this construction. And we don't expect them to be anything substantial amount. The next question is should we expect any yield load factor weakness in 2019 when 41 new aircraft will be added into your fleet?
In 2019, there will be 24 net aircraft increase. But the average number of aircraft in fleet, in the fleet, is going to be increasing less than 5%. With flight utilization ratios, we're going to be adding around 5% capacity in ASK terms, which will be most probably in line with [ higher plus ] average capacity growth. We might estimate [ slight ] load factors and yields in 2019 compared to 2018 considering the mild ASK growth projections.
Next question is from Cenk Orcan. Can you clarify what impact on Q2 net profit was there from accounting change of calculating FX gains losses on financial leases? I tried to answer this during the presentation, but let me try it again. At the beginning of this year, we decided to identify the foreign currency liabilities measured in euros, Japanese yen, Swiss franc as nonfinancial derivative instruments to hedge its highly probable forecast of revenues in these currencies. Because of this, the exchange rate differences arising from translation of these liabilities are recorded as cash flow hedge transactions under other comprehensive income in equity instead of profit loss statement. For the first 6 months, we have recorded $97 million unrealized foreign exchange gains in OCI instead of P&L, which consist of [ $115 million ] gain from euro, $4 million gain from CHF and $22 million losses from Japanese yen. Where do you see -- this is a question by Muharrem Gülsever. Where do you see the net debt at the end of 2018?
We see net debt will be around $7.5 billion level.
The next question is, what are your net debt EBITDAR and EBIT over interest ratios look like? Do you see -- do you foresee volatility with the new deliveries?
Although new aircraft orders increase our debt obligation, thanks to high cash generation ability as a result of strong operational performance, we expect net debt to EBITDAR ratio to fluctuate between 3x and 3.5x, which is our long-term average, and EBIT interest ratio to stay around 4x level.
This is from Artem Yamschikov from Renaissance Capital. Global aviation market is experiencing a pilot shortage. What is the situation in Turkey? Do you expect this issue to impact your operations in the future given that you will expand significantly at the new airport?
More than 85% of our pilots are Turkish citizens. For the remaining recruitments, we are traveling around the world, we have interviews with the candidate. Our offer package is welcome for both captain and pilot level. On the other hand, Turkish Airlines Training Academy is quite supportive on supplying important part of our first officer needs. We also recently provided a reasonable adjustment on the cockpit salaries in order to circumvent any possible losses from the Turkish lira depreciation. We do not expect major shortage in the coming years.
Next question is on CapEx. What is your CapEx projections for the following 3 years?
We expect to finalize 2018 with a CapEx around $2 billion. CapEx projection for the next year is around USD 3 billion, USD 3.5 billion. This CapEx is mostly required by the financing of new aircrafts. When we look at the future cash flow projections, we will be able to accommodate our CapEx expenditures.
Another question from Cenk Orcan from HSBC. Can you talk about the upcoming IFRS 16 impact on your financials -- operational lease becoming on the balance sheet items from January '19 and onwards? The accounting standard of IFRS 16, as you know, which will be applicable from 2019 and on, they mean that the lease liabilities are going to be recognized in the balance sheet. We have set up a groupwide project to implement these new leasing standards. Most important change that we could identify is that the group at THY, we will be recognizing these new assets and liabilities for our operating leases. Since operational lease aircraft make up a significant portion of our total fleet, the right of use assets will mainly related to aircraft. Furthermore, the type of expenses connected to these lease will change. Since IFRS 16 replaces the linear expenses for operating leases, with depreciation and amortization for right of use assets and interest expenses for lease liabilities. This will have corresponding effects on the presentation of results in the income statement, total assets, debt and equity ratio. It is -- while still a little early for reliably quantifying the concrete impact of these we'll have on the consolidated financial statements, but we will inform you as we get more through our analysis about the issue. The current status of our operating leases are shown in our audit report. Well, there is a question, especially today in the news that there are several questions regarding the acquisition of a stake in Sabiha Gokcen airport. What would you like to comment on this?
Actually, we should not address specific airport. When we establish our real estate and airport investment subsidiary, we gave some color about the high-level intention of acquiring some shares locally or internationally. The main motivation is the higher profitability margins of airlines operators, which perfectly fits our aim to distribute the business segments in aviation. We're interested in airport operator shares within our core business domain.
There is a question about the new report. What do you see as advantages of the new airport contributing to the demand and profitability for Turkish Airlines?
There are several advantages. We're able to assign more flights and traffic [ axis ] within the peak hours, thanks to increasing hourly traffic movements. This will decrease the waiting time for transit passengers and increase our efficiency. Second, the new airport will be able to serve higher capacity. Given that we will have more than 200 aircraft entering the fleet we should have capacity constraints at Atatürk Airport. Third, we're able to welcome new strategic partnerships for Asia, Europe, ex. Fourth, new slots will be possible in the countries where we cannot increase capacity due to unavailability of slots in Atatürk Airport. And fifth, the cargo capacity will be at least double the size of Atatürk Airport.
There is a series of questions about the move to the new airport. I will consolidate them and try to answer briefly about the operations. The Chairman actually this morning had a press conference where he gave quite a bit of an insight about the operation. Let me summarize them quickly. We are definitely getting ready at 100% with all related parties to operate in the new airport in the comment date of opening as the announce date. This project will be a milestone for Turkish Airlines as well as for Turkey, and all the related parties are working really hard to have the operation -- the transaction, the transition running smoothly. Actually, it will be overall a 1-day of delay. There will be 12 hours' period of shutdown time for Turkish Airlines starting on the 31st of October. But considering the planned capacity cuts, which are distributed through the week of 29th of October to the 1st of November, it's safe to say that there will be about 2 days in total for a smooth move to the new airport. According to our estimates, a total of roughly 200 fare flights will take place during the move. And out of total, about 150 will be from Atatürk and the remaining will be from the other airports. Also about the Cargo, we will be operating with temporary facilities for about 6 months for catering and cargo operations from our current establishments. The overall planned CapEx for the first phase of construction, as we have announced earlier, is going to be around $650 million to $700 million, which is an amount that we have already accumulated from the banks. Another question is, what is the impact of trade war between China and U.S. for Turkish Airlines?
Only impact could be on our cargo business. Less than 1% of our cargo business is exposed to the trade between China and U.S. routes. We don't expect a significant impact.
And the next question is about the new JVs. Currently, you terminated MOA with SATS and started to negotiate with DO & CO. What has changed with DO & CO and SATS so that you made such a critical decision?
Well, we had some disagreements in some of the key issues with SATS during the negotiation. Meanwhile, DO & CO shared an intention to continue our partnership with a noticeably improved offer. The process is still continuing, and we expect it to be completed soon.
And another question about the new airport from Cenk Orcan. What is your strategy at the new Istanbul airport? Will you focus on increasing international transfer passengers by offering more competitive prices?
Important part of the [ tax ] growth will be in the international transit segment. We're going to pursue growth not by merely offering competitive prices for transit passengers but having new strategic partnerships with airlines penetrating new markets and expanding our Cargo business.
And I'm taking 1 last question. This is from Olga Boltrukevich from VTB Capital. What are your expectations for the third quarter -- expectations for third quarter? Do you plan to deliver higher EBITDA during the third quarter of '18 versus last year?
We expect our EBITDA will increase around 5% in the third quarter compared to last year.
And I couldn't name all the question -- all the parties who asked the question. There were so many common questions. We appreciate your time, and thank you so much for your participation. I would like to thank on behalf of our shareholders and on behalf of Turkish Airlines staff since you participated this telecon. And hopefully, we will see you soon and talk to you soon with the also another Q results and also good result again. Thank you so much. I appreciate it.
Ladies and gentlemen, thank you for participating. You may now disconnect.