Turkish air transport... Flying with the lira

Beneficial weak lira…mostly. We believe air transport is one of the sectors in Turkey more immune to local FX weakness. Turkish Airlines (THY) sells 70% of its tickets outside Turkey and 86% of revenue in 9M13 was in currencies other than the Turkish lira. For TAV Airports, passenger fees set in euro and dollars amounted to 61% of its 9M13 revenue (total non-lira revenue accounted for c. 70%). Pegasus (PGSUS) collected 45% of its 9M13 revenue in lira. THY and TAV also have more costs than revenue in lira, making lira weakness margin-positive. Furthermore, their debt and interest rates are usually in FX – making local interest rate fluctuations largely irrelevant for the sector (much of this debt is also at fixed rates).

Positive outlook for THY. Traffic numbers for FY13 were strong and we see THY’s revenue passenger-kilometres (RPK) growing 18% in 2014 (vs 23% in 2013). We expect over 45% of the additional available seat-kilometres (ASK) in 2014 to come from wide-body planes, with the main focus on adding capacity on African routes and to the Americas, long-haul being a more lucrative area. THY’s focus on premium passengers (with their contribution to total revenue at less than half the rate for any other flag carrier) should also provide added support to yields. The company recently confirmed its 2014 target revenue growth of 17% in dollar terms, to $11.4bn; we forecast 12% growth, believing yields will moderately soften in 2014 due to competition. The adjustments to our model incorporate average FX rates of TRY2.2/$ and TRY2.9/EUR in 2014; margin support for 2015, as the company has signed a three-year contract with trade unions that envisages lower wage rises than we expected; and a higher use of wet-lease planes in 2014. An extra 10% weakening of the lira should also add 0.4 ppt to our 2014 EBITDAR margin projections. In the light of these adjustments we upgrade the stock to BUY, from Hold, with a new TP of TRY9.1/share (previously TRY8.5/share).

TAV AIRPORTS - Slightly better than expected: BUY

Strong growth y-y continues on traffic growth
TAV Airports posted earnings of EUR54m (up 36% y-y, BNPPe: EUR52, TAV consensus: EUR47m) in 3Q12 on EBITDA of EUR124m (up 24% y-y, BNPPe: EUR123m, consensus: EUR118m) and revenue of EUR335m (up 28% y-y, BNPPe: EUR321m, consensus: EUR318m). Growth was mostly driven by 33% y-y increase in the number of terminal passengers.

Operating performance slightly better than expected
While top line and EBITDA growth was impressive in 1H12, it was below the number of passengers with 12ppt of the passenger growth in 3Q12 coming from Izmir domestic terminal (acquired early 2012). We estimate margins were slightly pressured by strong TRY (13% y-y in real terms), which accounted for about 50% of costs but 35% of revenues in 9M12.

Reiterate BUY on valuation and likely LT upside from third airport
We reiterate our BUY rating for TAV Airports as it offers more than 35% upside potential to our 12-month target price of TRY12.50, based on SoTP. We especially recommend the stock for investors keen for exposure to the fast-growing Turkish aviation industry but wanting to avoid the volatility and lack of visibility for margins at Turkish Airlines. We think the government’s plan for a third airport in Istanbul is likely to create more upside risk for TAV Airports than downside in the long term.