Turkey’s political turmoil is taking its toll on the country’s two largest carriers, Turkish Airlines (THY) and Pegasus Airlines. Both companies feature in the list of the 10 most deteriorated airlines over the past 12 months provided by Airfinance Journal’s Financial Ratings (TAA).

THY has slipped by 1.2 points, earning a rating of “B” for the third quarter of 2016, while Pegasus Airlines has dropped by 2.5 points – the biggest fall of any of the 180 airlines covered by the service – receiving a rating of “B-”.

The ratings drop can largely be attributed to the spike in geopolitical risk that the country has endured since 2015. In September 2016, rating agency Moody’s cited the airline’s operating environment as a reason for downgrading THY’s corporate family rating to "Ba3" from "Ba2", with a negative outlook.

The impact of the geopolitical risk is twofold. Passenger revenues are down because tourists are less keen to travel to Turkey, while the airlines’ deteriorating balance sheets and the country’s political uncertainty have driven up financing costs. To make matters worse, the devaluation of the Turkish lira is driving up the relative price of the airlines’ dollar-denominated costs.

Falling margins, rising costs

As the data shows, Turkey’s two largest airlines suffered from declining yields and higher debt-to-earnings ratios last year.

THY’s total revenues fell 6% to $7.6 billion for the first nine months of 2016, compared with the same period in 2015, mainly down to declining passenger yields. Meanwhile, total operating costs for the same period rose 2.7% to $7.4 billion.

Its EBITDAR margins (earnings before interest, tax, depreciation, amortization and rent costs) have also taken a hit (see graph). For the third quarter of 2016, the last quarter for which financial results are available, THY’s EBITDAR margin was 21.5%, compared to 31.3% in the third quarter of 2015.

Meanwhile THY’s adjusted net debt to EBITDAR ratio at the end of the third quarter had risen to 4.7x, compared to 2.3x in the third quarter of 2015.

Pegasus Airlines’ EBITDAR margins are also down. For the third quarter of 2016, its EBITDAR margins fell to 32.7% from 35.3% in the third quarter of 2015.

Although total operating costs fell 1.2% to $908 million, total revenues also fell by 4.3% to $974 million.

Pegasus’ own adjusted net debt to EBITDAR ratio at the end of the third quarter had risen to 3.0x from 2.3x in the third quarter of 2015.

Source: The Airline Analyst

Financing and capacity

Naturally, both airlines have found it more difficult to finance their incoming aircraft, at least at the same rates as in 2015.

Pegasus Airlines recently admitted that it is paying higher financing costs than in the recent past.

“Is there a reflection in our cost of funding? Yes, for the time being,” said the carrier’s VP finance and strategic planning, Tamer Yuzuak, at Airfinance Journal’s 14^th Annual Middle East Conference in Dubai last year.

Banking sources tell Airfinance Journal that THY has attempted to close a capital markets structure in the past few months, but was prevented from doing so when some investors withdrew due to their interpretation of the political risk. The airline is now seeking alternative sources of finance, such as Korean institutional investment, but it has not disclosed whether deals have closed successfully or at what price.

Meanwhile, the fall in passenger demand has forced the airlines to reassess their capacity plans.

Before the wave of terrorist attacks, both airlines were expecting traffic growth above the global average, due to Turkey’s proximity to both Europe and the Middle East.  

The fall in passenger demand came at a particularly bad time for THY. With ambitious expansion plans, the carrier had placed a large number of orders with Boeing and Airbus: as of September 2016, its order book stood at 174 aircraft.

However, when demand for travel fell, the carrier was left with excess capacity. In response it organised a massive restructuring with the two manufacturers. In October 2016, it announced the redelivery dates of 167 narrowbody aircraft that were originally scheduled between 2018 and 2022.

The airline is also reportedly seeking to sub-lease three A330s to Russian charter specialist Nordwind Airlines.

However, Pegasus Airlines has chosen not to defer its orders with Airbus. Speaking on an airline panel at the 19^th Annual Global Airfinance Conference in Dublin, Serhan Ulga said: “We have 100 Airbus orders, and have received nine aircraft so far. We have not deferred any of our Airbus orders - instead we trying to advance them. We were the first airline to fly the CFM-powered Neo. In this rising fuel environment we thought it would be a good idea to have them as soon as possible.”