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What's Changed FROM TO

Turkish Airlines (THYAO.IS)Rating Equal-weight UnderweightPrice Target TL 19.50 TL 16.50

Pegasus Hava Tasimaciligi AS (PGSUS.IS)Rating Equal-weight UnderweightPrice Target TL 33.00 TL 19.00

Turkish Airlines: Key financial metricsTRY mn 12/17 12/18e 12/19e 12/20eRevenue 39,779 64,281 e 79,038 e 86,939 eEBITDA 8,044 13,053 e 12,617 e 16,126 eModelWare EPS 2.21 4.33 e 3.26 e 4.17 ePrior EPS NA 2.66 e 2.42 e 2.85 eEV/EBITDA 5.9 3.8 e 4.6 e 4.5 eNet debt/EBITDA 3.2 1.9 e 2.7 e 3.0 e

Pegasus: Key financial metricsTRY mn 12/17 12/18e 12/19e 12/20eRevenue 5,349 8,111 e 10,119 e 10,854 eEBITDA 735 1,017 e 961 e 1,134 eModelWare EPS 4.63 3.97 e 2.51 e 3.06 ePrior EPS NA 3.64 e 3.88 e 3.80 eEV/EBITDA 6.3 5.7 e 7.5 e 6.4 eNet debt/EBITDA 1.7 3.3 e 4.9 e 4.2 e

Unless otherwise noted, all metrics are based onMorgan Stanley ModelWare framework

** = Based on consensus methodology

* = GAAP or approximated based on GAAP

Source: Company data, Morgan Stanley Research, e= Morgan Stanley Research estimate, Priced as onOct 12, 2018

EEMEA TransportEEMEA Transport || Europe Europe

Turkey Aviation: Turbulenceahead? We turn sellers.We see rising risks into 2019 for Turkish carriers from upwardcost pressures and weaker demand outlook. Whilst valuationsappear cheap, earnings sensitivity is high. We turn sellers anddowngrade Turkish Airlines and Pegasus to Underweight.

Downgrade to Underweight: Turkish Airlines has outperformed the market by

28% YTD, supported by a strong demand environment and USD earnings. On our

revised estimates, we are 5-20% below FY19 EBITDA consensus for Turkish

Airlines and Pegasus respectively, driven by our cautious view on demand into

2019, and cost headwinds. Whilst valuation appears cheap at a FY19e EV/EBITDA

multiple of 4.6x , we believe high earnings sensitivity, third airport disruption risk,

and a tough macro environment could keep the stock cheap. On our estimates,

Pegasus trades at 7.5x FY19 EV/EBITDA.

Fuel headwinds ahead: $ Brent prices are up ~30% YTD (1.9x in TL terms). Our

analysis of airline yield and margin trends in periods of sharply rising fuel prices,

going back to 1980, suggests margin pressure ahead for carriers, as yield growth

lags higher costs. We forecast $83/bbl Brent for the Turkish carriers in 2019e,

based on the forward curve. This drives our estimate of +4-6% FY19 CASK USD

for Turkish Airlines and Pegasus respectively. Each $5/bbl has an 11% and 20%

FY19 EBITDA impact on Turkish Airlines and Pegasus respectively.

Turkey demand exposure could be higher than expected: Domestic represents

12% of scheduled passenger revenues for Turkish Airlines as of FY17. However,

taking into account international demand from Turkish residents, the exposure

increases to 30% for Turkish Airlines, and stands at 35-40% for Pegasus. 3Q18

traffic data for Turkish Airports shows the first signs of negative domestic

passenger growth in Turkey at -1%. For Turkish Airlines and Pegasus 3Q18 traffic

was up 2% and 6% respectively (vs 16% and 14% in 1H18, due to tougher comps),

with load factors up 1.6ppt and 0.5ppt supported by capacity constraints. We

forecast 0-1% traffic growth along with flat loads for the carriers in FY19e. We

assume yield growth lags costs, and this drives our RASK forecast of +1-1.5% for

THYAO and Pegasus respectively. Each 1% change in yield has a 5% and 7%

impact on Turkish Airlines and Pegasus FY19 EBITDA.

FX tailwinds, but personnel cost headwinds ahead: Turkish Airlines benefits

from an FX tailwind with 26% of costs in TL but only 14% TL revenues. However,

given global upward pressure on pilot salaries, we believe this is likely to be

partially offset by upward pressure on personnel costs for Turkish Airlines given

the 30% TL/USD depreciation since June. Further, we see risk of higher unit costs,

and disruption risk for Turkish Airlines with its move to the New Istanbul airport

in Dec 2018.

Morgan Stanley does and seeks to do business withcompanies covered in Morgan Stanley Research. As aresult, investors should be aware that the firm may have aconflict of interest that could affect the objectivity ofMorgan Stanley Research. Investors should considerMorgan Stanley Research as only a single factor in makingtheir investment decision.For analyst certification and other important disclosures,refer to the Disclosure Section, located at the end of thisreport.+= Analysts employed by non-U.S. affiliates are not registered withFINRA, may not be associated persons of the member and may notbe subject to NASD/NYSE restrictions on communications with asubject company, public appearances and trading securities held bya research analyst account.

1

October 15, 2018 11:01 PM GMT

mailto:[email protected]

mailto:[email protected]

Investment Thesis

Turkish Airlines is up 11% YTD, outperforming the BIST-100 by 28%. Pegasus is

down 27% YTD, underperforming the market by 11%. We believe Turkish Airlines'

outperformance is driven by a strong 9M18 demand environment, and its USD/EUR

driven earnings in a period of TL depreciation.

We turn more bearish on the Turkish carriers given our view of a weak demand

environment into 2019, cost headwinds from rising fuel prices, and disruption risks

related to the third airport move. We downgrade Turkish Airlines and Pegasus to

Underweight. Our Underweight call on both names is out of consensus with no

sell ratings on Turkish Airlines currently, and only one on Pegasus.

We prefer Autos in our Turkish Industrials coverage: Morgan Stanley's EEMEA

strategist has an Underweight rating on Turkey, based on the highest negative

earnings revisions and among the highest twin deficits within their coverage. In that

context, we believe Tofas and Ford Otosan are well positioned given their

significant export exposure.

We turn bearish on the Turkish carriers

Demand - we see a weaker environment in 2019

Exhibit 1: Turkish Airlines has outperformed the market YTD

Source: DataStream, Morgan Stanley Research. Brent price is shown in USD, all share prices/indices are in TL.

2

Turkish international arrivals grew 23% YoY in 8M18, driven by the continued recovery

of tourism post the slowdown in 2016. Domestic passenger traffic in Turkish airports

was up 13% YoY in 1H18, however in 3Q18, domestic passenger traffic growth turned

negative to -1% YoY.

Domestic: Prior downturns have seen domestic traffic decline 25% in Turkey: Given the

macro environment in Turkey, which has seen TL/USD depreciation, we have analysed

how domestic passengers have been impacted in previous downturns. Our analysis

shows that domestic passengers declined ~25% during the 2001. We acknowledge this

was before the air market liberalization in Turkey in 2003, hence the impact would likely

be lower in 2019, as fares in Turkey were higher given no low cost carriers at the time. In

addition to pressure from lower passenger growth, the domestic operations face

significant headwinds from the oil price movement, given the depreciation of the TL vs

USD. Whilst oil prices are up ~30% in USD terms, they are up 1.9x in TL terms. Domestic

prices in Turkey are capped at TL350/ticket, and we believe this suggests the full impact

of higher oil prices will not be reflected in domestic prices.

Our macro view - see report: CEEMEA Compass: Pressure's on again : 12th Oct

2018

The initial impact of higher interest rates and the weaker currency is starting to be

seen in the leading growth indicators including loan growth, PMI and confidence

indices. Yet, thanks to a stronger performance in 1H18 at 6.2%Y, we see GDP

growth remaining at 4.0%Y this year. We expect the economic slowdown to

become more pronounced from 4Q18, and see next year's growth at 0.8%Y.

Exhibit 2: Turkey tourist arrivals grew 23% YoY in 8M18

-50

-40

-30

-20

-10

0

10

20

30

40

50

Jan-

09Ju

n-09

Nov

-09

Apr

-10

Sep

-10

Feb-

11Ju

l-11

Dec

-11

May

-12

Oct

-12

Mar

-13

Aug

-13

Jan-

14Ju

n-14

Nov

-14

Apr

-15

Sep

-15

Feb-

16Ju

l-16

Dec

-16

May

-17

Oct

-17

Mar

-18

Aug

-18

Foreign Tourist Arrival % YoY 12m m a

Source: Datastream, Morgan Stanley Research

Exhibit 3: Turkey: Domestic passengers have turned negative sinceJuly this year

-5%0%5%

10%15%20%25%30%

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Jan-

18

Feb-

18

Mar

-18

Apr-

18

May

-18

Jun-

18

Jul-1

8

Aug-

18

Sep-

18

Domestic Tourist YoY

Source: DHMI , Morgan Stanley Research

3

Domestic exposure for the Turkish carriers could be higher than expected: Domestic

traffic accounts for ~45% of Turkish Airlines passengers, and 62% of Pegasus

passengers. In revenue terms, as of 1H18, ~11% of scheduled passenger revenues for

Turkish Airlines are domestic. However, taking into account Turkish residents traveling

internationally, Turkey exposure increase to ~30% for Turkish Airlines and ~35-40% for

Pegasus.

Exhibit 4: In prior macro slowdowns, domestic traffic in Turkey hasdeclined 25% YoY

Source: DHMI , Morgan Stanley Research

Exhibit 5: In local currency terms, oil prices in Turkey have increasedsignificantly


Exhibit 6: 45% of THYAO's passengers are domestic as of 1H18

45%

14%

31%

10%

1H18: Pax Breakdown

Domestic

Int'l Direct

Int'l-Int'l Transfer

Int'l-Domestic Transfer

Source: Company data, Morgan Stanley Research

Exhibit 7: ...Pegasus has 62% domestic passengers as of 1H18

62%

38%

1H18: Pax Breakdown

Domestic

International


4

International: Tough comps may mute growth in 2019: Turkish Airlines international

direct pax grew 21.5% YoY in 1H18, whilst Pegasus saw growth of 12% in international

passengers in 1H18, as international passengers continued to recover. However, this rate

of growth slowed down in 3Q18 for Turkish Airlines to 3% , due to tougher comps. For

Pegasus, international traffic growth remained at 12% in 3Q18, however load factors

turned negative in September. Whilst we expect international traffic to benefit from a

weak TL in 2019, we see potential growth headwinds from tough YoY comps, and a

slowdown of Turkish residents traveling internationally. In addition, IATA highlights that

continued trade tensions could impact passenger and cargo demand globally.

The carriers appear to be responding via capacity constraint: Our analysis of seat

capacity schedules from OAG shows that both Turkish Airlines and Pegasus appear to

be constraining capacity growth into 1Q19, with seat capacity growth of low single digits.

We view this positively for load factor trends. We note that in September, Turkish

Airlines capacity was down -1%, driving load factor growth of 2ppt YoY. For Pegasus,

load factor growth turned negative for the first time in 2018, in September, down -1.8ppt

YoY.

Exhibit 8: Revenue by point of sale for Turkish Airlines

29%

16%19%

13%

9%

10%4%

1H18: Revenue by Point of Sale

Europe

Turkey

Internet/Call Center

Far East

Middle East

America

Africa


Exhibit 9: Pegasus: Scheduled passenger revenue Breakdown (1H18)

Domestic, 45%

Europe, 37%

Other, 17%


Exhibit 10: Turkish Airlines: International direct traffic growth sloweddown in 3Q18 due to tougher YoY comps

-20%

-10%

0%

10%

20%

30%

40%

50%

2009

2010

2011

2012

2013

2014

2015

2016

2017

1Q18

2Q18

3Q18

Domestic Int'l - Int'l Transfer Int'l - Direct


Exhibit 11: Pegasus: International direct traffic was up 12% in 3Q18whilst domestic saw a slowdown to 2%

-20%

-10%

0%

10%

20%

30%

40%

50%

2009

2010

2011

2012

2013

2014

2015

2016

2017

1Q18

Domestic Int'l - Int'l Transfer Int'l - Direct

0%10%20%30%40%50%60%70%80%90%

2009

2010

2011

2012

2013

2014

2015

2016

2017

1Q18

2Q18

3Q18

Domestic International


5

We lower our traffic forecasts for the carriers for 2019: We lower our traffic growth

forecasts for Turkish Airlines and Pegasus to 0-1% growth in 2019, with flat load factors.

Our forecasts reflect our view that domestic traffic growth will be negative in 2019, and

international travel by Turkey residents will be negatively impacted as well.

Costs: We see headwinds from rising fuel costs

Exhibit 12: Turkish Airlines domestic capacity out of Istanbul

-5%

0%

5%

10%

15%

20%

25%

30%

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,5001Q

132Q

133Q

134Q

131Q

142Q

143Q

144Q

141Q

152Q

153Q

154Q

151Q

162Q

163Q

164Q

161Q

172Q

173Q

174Q

171Q

182Q

183Q

184Q

181Q

19

Dom

estic

Sea

ts ('

000s

)

Turkish Airlines Growth

Source: OAG, Morgan Stanley Research

Exhibit 13: Turkish Airlines international capacity out of Istanbul

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

2Q18

3Q18

4Q18

1Q19

Inte

rnat

iona

l Sea

ts ('

000s

)

Turkish Airlines Growth


Exhibit 14: Pegasus airlines domestic capacity out of Istanbul

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

-

500

1,000

1,500

2,000

2,500

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

2Q18

3Q18

4Q18

1Q19

Dom

estic

Sea

ts ('

000s

)

Pegasus Airlines Growth


Exhibit 15: Pegasus international capacity out of Istanbul

0%

5%

10%

15%

20%

25%

30%

35%

-

200

400

600

800

1,000

1,200

1,400

1,600

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

2Q18

3Q18

4Q18

1Q19

Inte

rnat

iona

l Sea

ts ('

000s

)

Pegasus Airlines Growth


Exhibit 16: Turkish Airlines: We forecast flat traffic growth along withflat load factors in 2019e

74%73%

78%79% 79%

78%

74%

79%

82% 82%

68%

70%

72%

74%

76%

78%

80%

82%

84%

0%

5%

10%

15%

20%

25%

30%

2010 2011 2012 2013 2014 2015 2016 2017 2018e 2019e

Traffic growth % Load factors %

Source: Company data, Morgan Stanley Research estimates (e)

Exhibit 17: Pegasus: We forecast 1% traffic growth along with flatload factors in 2019e

32%

20%24%

17%13%

8%

15%

7%1%

75%

78%

80% 80%79% 79%

85%86% 86%

70%

72%

74%

76%

78%

80%

82%

84%

86%

88%

0%

5%

10%

15%

20%

25%

30%

35%

2011 2012 2013 2014 2015 2016 2017 2018e 2019ePassenger growth YoY Load factors %


6

Oil prices are up ~30% YTD. Our analysis suggests that whilst Turkish Airlines should be

able to pass on fuel costs onto fares, it may be difficult to pass on enough to fully

compensate for the oil price increase.

Prior periods of sharp oil price increases have seen margins negatively impacted for the

industry: We have analysed global airline yield trends in periods of rising oil price going

back to the 1980s. Our analysis shows that whilst yields tend to follow Brent prices, in

periods of sharp increases, the extent of yield improvement does not fully offset oil

price movements, and such periods have often seen margins weaken YoY.

Turkish Airlines has historically offset fuel movements with both yield increase and ex

fuel cost control: Our analysis shows that historically, along with passing on fuel

movements to yields, Turkish Airlines has focused on non fuel CASK control to offset

some of the cost pressure from fuel increases.

2019 ex fuel costs could see headwinds: In 2019, we believe the company will continue

to focus on cost control. However, we see upside risk to ex fuel unit costs from the

move to the new Istanbul Airport, driven by potential disruption costs, as well as other

costs such as higher landing fees.

Exhibit 18: World airline yields tend to follow movements in Brentprices, but appear to lag periods of sharp oil price increases

-60%

-40%

-20%

0%

20%

40%

60%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Bren

t YoY

cha

nge

%

Yiel

ds Y

oY c

hang

e %

Yields YoY change % Brent Price

Source: ICAO, IATA, Morgan Stanley Research

Exhibit 19: Operating margins for the industry are close to peak levels,and sharp oil price increases have historically seen industry marginsweaken YoY

Source: ICAO, IATA, Morgan Stanley Research

7

Part of the TL benefit for Turkish Airlines could be offset by higher personnel costs:

Turkish Airlines is primarily a USD/EUR denominated business. In terms of its TL

exposure, ~26% of expenses and 14% of revenues are in TL. A key driver of the TL based

costs are personnel costs for Turkish Airlines. Personnel costs represent ~17% of the

company's total costs. Given the depreciation of the TL/USD, Turkish Airlines agreed to a

salary increase of 20% for pilots, and 10% for other personnel in June this year. With

another ~30% depreciation since the start of June, we believe the company may need to

further increase pilot salaries.

Exhibit 20: Historically, Turkish Airlines has passed on part of the fuelprice movement onto yields, along with focusing on control of ex fuelCASK

(50)(40)(30)(20)(10)

-1020304050

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

RASK YoY change Fuel CASK YoY change % CASK ex fuel


Exhibit 21: Achieving RASK change in line with CASK is key tooperating margins for Turkish Airlines

(6.0)(4.0)(2.0)-2.04.06.08.010.012.014.0

(25)

(20)

(15)

(10)

(5)

-

5

10

15

20

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

RASK YoY change CASK YoY change EBIT margin


Exhibit 22: THY FX exposure: Revenue and cost split (2Q18)

22%13%

5%

14%26%

37%56%

20%

1%1% 5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Revenue Costs

% s

plit

EUR EUR Corr. TL USD USD Corr. JPY Others

Source: Company data, Morgan Stanley Research. Note: Corr: Currencies that have 85% correlation with USDand EUR considered as USD and EUR correlated respectively.

Exhibit 23: Personnel costs are the second largest driver of costs forTurkish Airlines

5%

31%

16%9%

6%

9%

5%

7%

3% 9%

Operating Leases

Fuel expense

Personnel costs

Landing & Traffic fees

Ground Handling

Sales and MarketingExpenses


8

Globally, we see fuel prices being reflected more in premium than economy yields: We

believe, given the macro environment in Turkey, it will be tough for Turkish Airlines to

increase yields. On the international front, according to IATA, for global airlines, the fuel

price movements is only being passed onto premium yields, and airlines have been trying

to offset cost pressures by increasing load factors this year.

Exhibit 24: Pegasus FX exposure: More exposed than Turkish Airlinesto TL depreciation

29%22%

38%

20%

30%

56%

3% 2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Revenue Costs

% s

plit

EUR TL USD Others


Exhibit 25: Fuel hedging for global carriers

0% 0%10%

25%34%

47% 50%60%

66%72% 75% 78% 79%

90%

0%10%20%30%40%50%60%70%80%90%

100%

Cop

a H

oldi

ngs

Indi

go A

irlin

es

Air A

sia

Nor

weg

ian

Pega

sus

Turk

ish

Airli

nes

Air A

rabi

a

AF-K

LM

Wiz

z Ai

r

IAG

easy

Jet

Lufth

ansa

Sout

hwes

t

Rya

nair

Source: Company data. easyJet FY18 to Sept. Wizz and Ryanair for 9m FY19 to March. Southwest till Dec 2018.

Exhibit 26: THY: Debt by Currency (1H18)

USD, 21%

EUR, 43%

JPY, 33%

CHF, 3%


Exhibit 27: Pegasus: Debt by Currency (1H18)

Euro, 54%

USD, 46%


9

Our forecasts assume RASK-CASK differential widens in 2019, driving lower margins

for the carriers: We assume that fuel headwinds for the Turkish carriers are not fully

passed onto prices, resulting in a widening of the RASK-CASK differential. We assume

RASK$ growth of 1% YoY for Turkish Airlines and +1.5% for Pegasus. We assume $ CASK

is 5.5% and 4% respectively for the carriers. This results in 2019e EBITDAR margins of

20.3% for Turkish Airlines and 19.8% for Pegasus.

Exhibit 28: IATA data shows that higher fuel prices are only beingreflected in premium cabin yields

Source: IATA, Morgan Stanley Research

Exhibit 29: 22% of Turkish Airlines revenues are driven by businesspassengers


Exhibit 30: Turkish Airlines: We forecast 1% growth in $RASK in 2019evs $CASK of 5.5%

-25

-20

-15

-10

-5

-

5

10

15

20

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

e

2019

e

YoY

chan

ge %

RASK (USD) CASK (USD)


Exhibit 31: Pegasus: We forecast ~1.5% growth in $RASK in 2019e vsand $CASK of 4%

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

2011 2012 2013 2014 2015 2016 2017 2018e 2019eCASK (USD) RASK (USD)


10

We see downside risk to consensus: On our revised estimates, we are 5-20% below FY19

EBITDA consensus for Turkish Airlines and Pegasus, respectively.

Valuations to remain pressured, earnings sensitivity high

Over the last decade, Turkish Airlines has risen ~14.5x vs ~1.6x for the BIST-100. The

stock outperformed the market in 2008-09 as well. We think this robust performance

has been driven by the strong growth Turkish Airlines has delivered over the last

decade, with EBITDA growth of ~7x between 2008-17, and a continued strong

operational performance in 2008-09. The stock has underperformed the market in

periods such as 2016 (-30% absolute and -40% relative) when demand was impacted by

security concerns in Turkey, resulting in load factor decline. Pegasus was listed in 2013,

and underperformed the market in 2015-16 on company-specific operational weakness.

On a 12 month fwd EV/EBITDA basis, since 2008, Turkish Airlines has traded in line with

Exhibit 32: Turkish Airlines: We forecast EBITDAR margin of 20.3% in2019

17.9% 18.8%

23.5%

15.1%

25.1% 24.7%

20.3%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2013 2014 2015 2016 2017 2018e 2019e

Mar

gin

EBIT

DA (T

Lmn)

EBITDA EBITDAR margin


Exhibit 33: Pegasus: We forecast EBITDAR margin of 19.8% for 2019

15.8%

12.4%

21.1%22.1%

19.5% 19.4%

15.0%

24.4%22.2%

19.8%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

-

200.0

400.0

600.0

800.0

1,000.0

1,200.0

2010 2011 2012 2013 2014 2015 2016 2017 2018e 2019e

EBITDA EBITDAR margin


Exhibit 34: Turkish Airlines: MSe vs. Consensus

2019 2020RevenueReuters- Median 68,113 87,076Morgan Stanley 79,038 86,939% Difference 16.0 (0.2)

EBITDAReuters- Median 13,305 14,262Morgan Stanley 12,617 16,126% Difference (5.2) 13.1

Net incomeReuters- Median 4,402 4,438Morgan Stanley 4,494 5,752% Difference 2.1 29.6

Source: Company data, Morgan Stanley Research, e = Morgan Stanley Research estimate

Exhibit 35: Pegasus: MSe vs. Consensus

2019 2020RevenueReuters- Median 9,115 10,478Morgan Stanley 10,119 10,854% Difference 11.0 3.6

EBITDAReuters- Median 1,198 1,507Morgan Stanley 961 1,134% Difference (19.8) (24.7)

Net incomeReuters- Median 405 405Morgan Stanley 305 375% Difference (24.5) (7.2)

Source: Company data, Morgan Stanley Research, e = Morgan Stanley Research estimate

11

the Turkish non financials index. However, since 2012, it has traded at a 12% premium to

Turkish non financials on average. At current levels, we estimate Turkish Airlines is

trading at a 15% premium to the Turkish non financials at 4.0x. Our PT for Turkish

Airlines implies 4.5x FY19 EV/EBITDA, a 13% premium to non financials.

THY has traded at a ~50% premium to EU network peers since 2012. At current levels,

on our estimates, the premium stands at 57%. Our PT implies a premium of ~50%.

THY has historically traded at a forward multiple of 6.0x since 2008. The trough fwd

EV/EBITDA for Turkish Airlines in 2009, was 2.0x. Whilst at 4.5x FY19 EV/EBITDA the

stock appears cheap relative to history, we believe this is justified by the risk of margin

and earnings headwinds ahead.

Since listing, Pegasus has traded at an average premium of ~40% to the Turkish non

financials index. During 2016, when operations at Pegasus were negatively impacted by

security concerns in Turkey, this rose to 60%, and in 2017 to 133%. At current levels, at

7.5x, we estimate Pegasus trades at a premium of 87% to the non financials. Our target

for Pegasus implies 7.0x FY19 EV/EBITDA, ~70% premium to non financials. Pegasus'

historical fwd EV/EBITDA multiple has been 7.6x.

For Pegasus, the historical premium vs LCC peers is ~18%. On our estimates, at current

levels, it is trading at a 30% premium, while our PT implies a premium of ~20%.

Based on our 2018-20e EBITDA CAGR, Pegasus offers ~6% growth with a RNOA of 4%.

This compares to EU LCCs, Ryanair and Easyjet, at 5.9x and 4.6x, with 10-15% growth and

higher returns at 18-23%. The global LCC median multiple is 5.7x, with higher growth

than Pegasus at 15% and higher return at 11%. We believe Pegasus' higher multiple is

driven by trough earnings estimates for 2019 on our numbers.

Turkish Airlines offers higher growth at 11% 2018-20e EBITDA CAGR vs 6% for Pegasus.

Leverage at Turkish Airlines is 3.6x FY19 net debt/EBITDA vs 6.0x for Pegasus. Returns

are higher at 8% vs 4% for Pegasus. THY has a stronger and more stable operating

history, and one could argue that a discount is not warranted vs Pegasus. However,

given risks related to the third airport move, and slowing growth, we think the low

valuation could continue until we have more clarity on how operations are evolving at

the new airport, and how 2019 demand is doing. In addition, we note the high multiple

for Pegasus is being driven by trough earnings. We highlight that Pegasus has higher

financial and operating leverage than Turkish Airlines, resulting in higher earnings

sensitivity to key drivers such as traffic, yields, and fuel.

12

Exhibit 36: Turkish Airlines: 12 month fwd EV/EBITDA

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Jan/

08M

ay/0

8S

ep/0

8Ja

n/09

May

/09

Sep

/09

Jan/

10M

ay/1

0S

ep/1

0Ja

n/11

May

/11

Sep

/11

Jan/

12M

ay/1

2S

ep/1

2Ja

n/13

May

/13

Sep

/13

Jan/

14M

ay/1

4S

ep/1

4Ja

n/15

May

/15

Sep

/15

Jan/

16M

ay/1

6S

ep/1

6Ja

n/17

May

/17

Sep

/17

Jan/

18M

ay/1

8S

ep/1

8

1 ye

ar fw

d EV

/EB

ITD

A Average since 2008: 6.0x


Exhibit 37: Turkish carriers 12 month fwd EV/EBITDA vs Turkish nonfinancials

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

Jan-

08M

ay-0

8Se

p-08

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

Jan-

14M

ay-1

4Se

p-14

Jan-

15M

ay-1

5Se

p-15

Jan-

16M

ay-1

6Se

p-16

Jan-

17M

ay-1

7Se

p-17

Jan-

18M

ay-1

8Se

p-18

12m

Fw

d EV

/EBI

TDA

Turkey Non Fin Index THY Pegasus


Exhibit 38: Pegasus: 1 year Fwd EV/EBITDA


13

Comparable Valuations

Exhibit 39: Global Network Comps

Company Name Fiscal Mkt Cap.Year End (LC) (USD bn.) 18e 19e 2018-20e 18e 19e 18e 19e 18e 19e 19e 19e

Network carrier compsTurkeyTurkish Airlines Dec 17.5 4.1 3.8 4.7 11.1 4.0 5.4 0.0 0.0 0.8 0.7 8% 50Pegasus (LCC) Dec 24.8 0.4 5.7 7.5 5.6 6.3 9.9 0.0 0.0 0.8 0.7 4% 65

EMEAAeroflot^ Dec 102.0 1.7 3.5 3.0 19.3 6.9 5.1 8.8 9.5 1.5 1.7 8% 78

EuropeAir France - KLM Dec 8.2 4.1 3.0 2.5 5.9 6.9 4.3 0.0 0.0 1.2 0.9 6% 59Aegean Airlines^ Dec 6.7 0.6 4.0 3.5 6.0 7.8 7.8 8.1 8.0 1.7 1.6 9% NAIAG Dec 6.7 17.1 3.0 3.0 (3.1) 4.8 5.9 4.5 4.4 1.6 1.4 28% (18)Deutsche Lufthansa AG Dec 19.2 10.4 2.5 2.0 9.8 4.9 4.2 4.6 7.1 0.8 0.7 11% 34Median 3.0 2.8 6.0 5.9 5.1 4.5 5.7 1.4 1.2 10% 34

USDelta Airlines Dec 52.1 37.9 4.9 4.6 2.8 9.1 9.0 2.4 2.7 16.7 7.0 15% 84United Continental Holdings Inc. Dec 80.2 24.4 5.2 4.8 9.2 11.3 10.1 0.0 0.0 8.0 6.1 9% 88Alaska Air Group Inc. Dec 61.6 7.6 5.0 4.3 13.3 15.1 12.7 2.1 2.3 2.0 1.8 10% 45Hawaiian Holdings Inc. Dec 33.5 1.9 2.6 3.0 (8.0) 5.0 7.1 1.4 1.4 1.8 1.5 14% 44American Airlines Group Dec 30.9 15.2 4.3 4.4 2.6 7.1 8.2 1.6 1.8 7.4 3.6 7% 89Median 4.9 4.4 2.8 9.1 9.0 1.6 1.8 7.4 3.6 10% 84

LatamCopa Holdings Dec 77.3 3.3 5.6 5.5 12.5 9.4 9.0 4.5 3.8 1.4 1.3 11% 35LATAM Airlines Dec 9.3 5.6 5.0 4.7 9.2 15.1 11.4 0.8 1.1 1.5 1.4 7% 68Median 5.3 5.1 10.8 12.2 10.2 2.7 2.4 1.5 1.4 9% 52

Asia PacificAir China Limited Dec 6.7 14.3 7.1 5.9 11.2 14.6 7.4 1.6 3.2 1.0 0.9 8% 49Cathay Pacific Airways Dec 11.0 5.5 7.3 6.1 13.6 34.3 10.2 1.0 3.4 0.7 0.6 5% 50China Airlines^ Dec 9.1 1.6 7.3 6.9 5.6 45.6 36.1 0.0 0.0 0.8 0.8 0% 59China Eastern Airlines Dec 4.3 9.5 8.0 6.9 13.9 11.3 7.3 0.0 0.0 0.9 0.8 5% 66China Southern Airlines Dec 4.3 9.7 6.4 6.0 12.1 9.5 5.9 1.8 2.9 0.7 0.6 5% 39EVA Airways^ Dec 14.1 2.0 5.4 4.8 7.3 13.0 13.6 2.0 0.0 1.0 0.9 2% 40Asiana Airlines^ Dec 3,905 0.7 7.1 7.0 9.7 7.1 5.9 0.0 0.0 0.6 0.6 2% 73Korean Air^ Dec 25,750 2.2 6.3 5.7 6.0 NA 6.4 1.0 1.0 0.7 0.6 2% 77Singapore Airlines Mar 9.3 7.9 6.1 6.6 12.1 15.4 14.2 3.2 3.5 0.8 0.8 6% 27Qantas Airways^ Jun 5.5 6.5 3.8 3.9 (3.3) 8.6 8.8 3.1 3.6 2.3 2.3 7% 34Virgin Australia Holdings^ Jun 0.2 1.3 6.5 6.2 2.8 NA 30.7 0.0 0.0 1.7 1.7 3% 50ANA Holdings Mar 3,671.0 11.3 5.2 5.0 3.9 10.0 9.5 1.9 2.2 1.1 1.0 7% 33Median 6.5 6.0 8.5 12.2 9.1 1.3 1.6 0.9 0.8 5% 49

Global Median 5.2 4.8 9.2 9.4 8.2 1.6 2.2 1.2 1.0 7% 50

RNOA% Net Gearing %Div. Yield(%) P/BVSharePrice EV/EBITDA P/E

EBITDACAGR

Source: Company data, Morgan Stanley Research, e = Morgan Stanley Research estimates. Companies marked with ^ are Thomson Reuters estimates. Priced as on October 12, 2018

14

Exhibit 40: Global LCC Comps

Company Name Fiscal Mkt Cap.Year End (LC) (USD bn.) 18e 19e 2018-20e 18e 19e 18e 19e 18e 19e 19e 19e

LCC compsTurkeyPegasus Dec 24.8 0.4 5.7 7.5 5.6 6.3 9.9 0.0 0.0 0.8 0.7 4% 65Turkish Airlines (Network) Dec 17.5 4.1 3.8 4.7 11.1 4.0 5.4 0.0 0.0 0.8 0.7 8% 50

EMEAAir Arabia Dec 0.96 1.2 5.7 5.1 2.0 9.3 8.9 8.1 8.4 0.7 0.7 7% 9Jazeera^ Dec 0.7 0.5 21.1 20.2 NA 18.6 14.9 4.7 4.7 3.9 3.3 23% (74)Median 13.4 12.6 2.0 13.9 11.9 6.4 6.5 2.3 2.0 15% (32)

EuropeeasyJet Sep 1,200.0 6.3 5.8 4.6 10.1 9.6 8.6 3.5 5.7 1.6 1.5 18% 4Norwegian Air Dec 200.0 0.9 7.2 7.2 43.7 NA NA NA NA 104.3 (6.6) 1% 101Ryanair Mar 11.5 16.0 7.0 5.9 14.5 13.7 10.5 0.0 0.0 2.7 2.2 23% 1Wizz Air Mar 2,458.0 4.1 5.8 4.4 29.0 11.3 9.3 0.0 0.0 2.3 1.8 1% (168)Median 6.4 5.3 21.8 11.3 9.3 0.0 0.0 2.5 1.6 9% 3

USJetBlue Airways Corp. Dec 16.4 5.4 4.0 4.0 12.2 10.6 10.5 0.0 0.0 1.1 1.0 7% 26Southwest Airlines Dec 57.4 35.3 6.6 5.7 7.6 12.7 10.7 1.0 1.1 3.1 2.8 24% 12Spirit Airlines Dec 47.1 3.3 5.4 5.0 19.0 11.2 10.2 0.0 0.0 1.2 1.1 9% 37Allegiant Travel Co. Dec 119.7 1.9 7.3 7.0 19.1 12.4 10.9 2.4 2.7 3.0 2.6 14% 59Median 6.0 5.3 15.6 11.8 10.6 0.5 0.5 2.1 1.8 11% 31

LatamGol Airlines ^ Dec 7.4 1.0 6.6 5.7 18.9 (7.3) 12.8 1.2 3.3 (1.3) (1.4) 460% 139Volaris Dec 7.1 0.7 -9.4 6.1 NA (11.8) 14.2 0.0 0.0 1.6 1.3 13% (9)Median -1.4 5.9 18.9 -9.6 13.5 0.6 1.7 0.2 (0.0) 237% 65

Asia PacificAir Asia Dec 2.7 2.2 6.3 4.8 NA 5.6 5.3 7.3 2.9 1.0 0.8 13% 25Indigo Mar 808.6 4.2 36.7 30.7 51.3 43.5 39.9 0.3 0.5 4.0 3.8 NA NMSpring Airlines Dec 33.5 4.4 13.5 12.6 16.0 20.5 14.8 0.7 0.9 2.3 2.0 7% 27Median 13.5 12.6 33.6 20.5 14.8 0.7 0.9 2.3 2.0 10% 26

Global Median 6.3 5.7 15.2 10.9 10.5 0.5 0.7 1.6 1.3 11% 26

RNOA% Net Gearing %Div. Yield(%) P/BVSharePrice EV/EBITDA P/E

EBITDACAGR

Source: Company data, Morgan Stanley Research, e = Morgan Stanley Research estimates. Companies marked with ^ are Thomson Reuters estimates. Priced as on October 12, 2018

15

Turkish Airlines

Changes to our estimates and price target

FX: We update our average 2019e FX forecasts to EUR/USD 1.15 (from 1.17) and TL/USD

6.10 (from 4.58), based on spot levels.

Traffic: We forecast 2019e flat traffic growth (vs. 5% previously) and flat ASK growth

(5% previously). This implies 2019e load factor of 81.5% , flat YoY

Yields and costs : We forecast 2019e RASK ($) growth of 1%. We forecast CASK ($) to

increase by ~5.5% for 2019e (vs. 4% previously). We forecast a $83/bbl (vs. $75/bbl

previously) fuel price for FY19e, based on the forward curve. We forecast CASK ex-fuel

($) to grow ~3% in 2019e, driven by higher wages, and third airport move.

We forecast 2019e EBITDAR margin of ~20%, a decline from 25% in FY18.

Turkish Airlines price target of TL16.5 We lower our price target by 15% to TL16.50 as

the forecast increases mentioned above are more than offset by more conservative

assumptions in terms of both target multiple and WACC, as discussed below.

THYAO.IS

Valuation Methodology

We value Turkish Airlines on a weighted average of the following valuation approaches

to reflect both near-term earnings and long-term growth.

Our price target implies a FY19 EV/EBITDA of 4.5x. This would reflect a premium to EU

carrier peers, similar to history. This would imply a premium of ~13% to Turkish non

financials in line with average since 2012.

Key risks to price target

Target multiple (50% weighting): We apply a multiple of 4.5x to Turkish

Airlines’ FY19 EBITDA. This is lower than our previous 6.0x target multiple and at

a discount to history to reflect earnings headwinds in the near term. This is at a

premium to EU network peers given higher growth at Turkish Airlines.

DCF (50% weighting): We increase our WACC to reflect a higher cost of equity

for Turkey. We use a WACC of 12.6% (vs 11.9% previously) and a terminal growth

rate of 2.5% for our DCF valuation. We assume a CoE of 22%.

Better/Worse-than-expected yields.

Better/Worse-than-expected load factors

Higher/Lower-than-expected fuel prices.

EUR/USD depreciation.

Lower/Higher than expected third airport move cost.

Government stake sale.

16

Exhibit 41: Turkish Airlines: Changes to our estimates

2019e 2020eRevenue (TL mn)Old 62,479 67,762New 79,038 86,939% change 26.5 28.3EBITDA (TL mn)Old 10,649 12,639New 12,617 16,126% change 18.5 27.6RPK growthOld 5.0 10.0New 0.0 10.0% change (pp) (5.0) -RASK $ YoY change %Old 3 (2)New 1 -% change (pp) (1.5) 1.8CASK $ YoY change %Old 4 (2)New 6 (2)% change (pp) 1.5 0.4TL/USDOld 4.58 4.58New 6.10 6.10USD/EUROld 1.17 1.17New 1.15 1.15

Source: Morgan Stanley Research estimates (e)

17

Pegasus

Changes to our estimates and price target

FX: We update our average 2019e FX forecasts to EUR/USD 1.15 (from 1.17) and TL/USD

6.10 (from 4.58), based on spot levels..

Traffic: We forecast 2019e 1% traffic growth (vs ~10% previously). We expect flat load

factor for Pegasus Airlines.

Yields: We forecast $RASK of +1.6% vs 0.7% previously to reflect Pegasus plans of

reflecting higher TL fuel prices into domestic fares. We assume this is below the increase

in fuel prices and results in margin pressure.

Costs: We forecast a $83/bbl ( vs $75/bbl previously) fuel price for FY19e, based on the

forward curve. We forecast $CASK +4% YoY vs +2% previously.

Our FY19 EBITDA is down by ~19%. We are ~20% below consensus for 2019 EBITDA.


Our price target of TL19 is based on the average of DCF and target multiples. Our price

target declines from TL33 to TL19 (-40%).

Target multiple (50% weighting): We use a 6.0x target multiple applied to FY19 EBITDA

vs 6.5x previously to reflect demand headwinds into 2019. This is lower than 7.5x

historically. This is at a premium to LCC peers, and we highlight that this is being driven

by trough earnings.

DCF (50% weighting): Discounted cash flow valuation, driven by our base case profit

forecasts. We now use a WACC of 12.6% vs 11.9% previously to reflect higher cost of

equity in Turkey. We use a terminal growth rate of 2.5% for our DCF valuation. We

assume a CoE of 22%.


Upside risks: Better-than-expected yields; better-than-expected demand.

Downside risks: Lower-than-expected yields; higher-than-expected CASK; slower

international growth and increased competition.

18

Exhibit 42: Pegasus: Changes to our estimates

Source: Morgan Stanley Research estimates, YoY = Year on Year

19

Price TargetPrice Target TL16.5TL16.5

BullBull TL24.0TL24.0

BaseBase TL16.5TL16.5

BearBear TL5.3TL5.3

Why Underweight?

Demand headwinds: Exposure to Turkey is30%, including Turkish residents flyinginternationally. 2019 international demandgrowth could face headwinds from toughcomps.

Fuel cost headwinds: Oil prices are up 30%YTD in USD and 1.9x in TL. The fuel priceincrease may not be fully passed into yields.

TL benefit may be partially offset: 26% ofcosts and 14% revenues are in TL. The keydriver of TL costs is personnel and we believepilot salaries will likely be increased to reflectTL depreciation.

Risk reward skewed downwards: with 70%downside to bear case and 37% upside to bearcase.

Limited visibility on potential one-off costs

or disruptions related to third airport move:Turkish Airlines will move to the third airportend of December. Our case study analysisshows there could be disruptions and one-offcosts related to this move, which are difficultto forecast.

Key Value DriversYields: Each 1% change in FY19 yield growth

has a ~5% impact on EBITDA.

Fuel: Each US$5/bbl change in the FY19 oilprice has a ~11% impact on EBITDA.

Ex-fuel costs: Each 1% change in FY19 ex-fuel cost growth affects EBITDA by ~4%.

FX: Each 1% change in EUR/USD has ~1%impact on FY19 EBITDA.

Potential CatalystsMonthly traffic updates

3Q18 results in November

Fuel price movements

2019 budget announcement in January

Risks to Achieving Price TargetAnnouncements on progress of the airport

move

Better/worse-than-expected yields, loadfactors or fuel price

Risk-Reward: Turkish Airlines (THYAO.IS), Under-weight, PT TL16.5Risk-Reward: Turkish Airlines (THYAO.IS), Under-weight, PT TL16.5

Cost and demand headwinds, risk reward skewed downwardsCost and demand headwinds, risk reward skewed downwards

Source: Thomson Reuters (historical share price data), Morgan Stanley Research estimates

Weighted average of DCF (50%) and target multiple (base case) (50%)to reflect near-term earnings and long-term growth (WACC 12.6%;terminal growth 2.5%). We apply a target multiple of 4.5x to FY19eEBITDA.

Stronger demand, lower costs associated with third airport: We assume FY19etraffic growth of 5%, with flat load factors. $ RASK increases ~1% in FY19e. CASKgrowth is 3%, leading to ~21.5% EBITDAR margin. Our bull case is based on a50% weighting to our target multiple of 4.5x FY19 bull case EBITDA and 50% toour DCF. WACC of 12.6% and terminal growth of 2.5%.

Demand growth remains strong: We assume traffic and load factors are flat in2019. $RASK grows 1% in 2019e. CASK $ growth is 5.5%. EBITDAR margin of~20% in FY19e. We assume a $83/bbl fuel price in FY19e, based on the forwardcurve. We apply a target multiple of 4.5x to FY19e EBITDA. Our PT (based on50% DCF and 50% target multiple) is based on a premium multiple to EUnetwork peers given THYAO's higher growth.

Higher cost and capex driven by third airport move, weaker demand: Weassume higher one-off costs in 2018-19 related to the move. We assume yieldsand load factors are lower vs our base case. Our bear case is based on a targetmultiple of 4.5x FY18 EBITDA.

20

Government stake sale

21

Price TargetPrice Target TL19TL19

BullBull TL37TL37

BaseBase TL19TL19

BearBear TL6TL6

Why Underweight?

Weak outlook for domestic demand: Weforecast 1% traffic growth with flat loadfactor for 2019e. Domestic exposure forPegasus represents 35-40% of revenuesincluding Turkish residents travellinginternationally.

Yield growth below cost growth: Weforecast FY19e yields $ RASK of +1.6% YoY,while $CASK is +4%. Our estimates suggest anEBITDAR margin of 20%.

Fuel headwinds: In TL terms, oil prices areup 1.9x YTD implying margin pressure fordomestic operations.

Risk reward skewed downwards: We have76% downside to our bear case with ~49%upside to our bull case.

Key Value Drivers

Yields: Each 1% change in FY19e yieldgrowth has a ~7% impact on EBITDA

Fuel: Each US$5/bbl change in the FY19eoil price has a ~20% impact on EBITDA

Ex-fuel costs: Each 1% change in FY19e ex-fuel cost growth impacts EBITDA by ~6%

FX: Each 1% change in EUR/USD has a ~6%impact on FY19e EBITDA

Potential Catalysts3Q18 results in November

Monthly traffic updates

Fuel price movement

2019 guidance with FY18 results

Risks to Achieving Price TargetBetter/worse-than-expected yields

Better-than-expected CASK

Better/worse-than-expected demand

Increased competition

Risk-Reward: Pegasus Airlines (PGSUS.IS, UW, PT TL19.5)Risk-Reward: Pegasus Airlines (PGSUS.IS, UW, PT TL19.5)

Weakening domestic demand outlook, risk reward skewed downwardsWeakening domestic demand outlook, risk reward skewed downwards

Source: Thomson Reuters (historical share price data), Morgan Stanley Research estimates

Average of DCF (50%) and target multiple (50%), to reflect near-termearnings and long-term growth. WACC 12.6%; terminal growth 2.5%.We apply a target multiple of 6.0x to FY19e EBITDA.

Higher than expected demand growth: Traffic growth of ~7% in FY19e with 1ppthigher load factor YoY. $ RASK is +4% in FY19 vs +4% $ CASK. Ancillaryrevenues of ~€11.9/pax in 2019e. Higher operating leverage drives EBITDARmargin of ~22% for FY19e. Our bull case is based on a 50% weight to our targetmultiple of 6.0x FY19e EBITDA, and 50% to our DCF.

Slowdown in demand due to domestic weakness: Pax traffic growth of ~1% in2019e driving flat load factors in 2019e. We forecast +1.6% $ RASK in FY19e, vs.$CASK +4% on average for FY19e. This drives EBITDAR margin of ~20% in FY19e.We assume a US$83/bbl fuel price for FY19e. We apply a target multiple of 6.0xto FY19e EBITDA. Our PT (based on 50% DCF and 50% target multiple) is basedon a multiple which is at a premium to peers and Turkish non financials giventrough earnings

Competition and demand are worse than expected: Slow demand growth of -3% in FY19e with -2ppt load factor. Yields are flat whilst CASK $ is up 4%. Ourbear case fair value is based on a target multiple of 8x FY19 EV/EBITDA.

22

Financial Summary

Exhibit 43: Turkish Airlines: Key financial metrics, 2016-20eIn T R Y m m except per share data

IN C O M E ST AT EM EN T 12/16 12/17 12/18e 12/19e 12/20e M AR G IN S 12/16 12/17 12/18e 12/19e 12/20e

R evenue 29,468 39,779 64,281 79,038 86,939 EBITD AR M arg in (% ) 15.1 25.1 24.7 20.3 22.9

EB IT D AR 4,464 9,965 15,849 16,035 19,886 EBITD A M arg in (% ) 10.1 20.2 20.3 16.0 18.5

EB IT D A 2,976 8,044 13,053 12,617 16,126 EBIT M arg in (% ) (1 .7) 10.4 12.8 8.5 10.3

D &A and associa tes (3 ,470) (3 ,893) (4 ,842) (5 ,891) (7 ,210) N et In te rest M arg in (% ) 1.1 2.3 1.8 1.7 2.3

EB IT (494) 4 ,151 8,211 6,726 8,916 Effective Tax R ate (% ) N A 21.4 21.7 21.7 21.7

N on-op associa tes and o ther 828 (2 ,438) 1 ,285 250 250 N et Income M arg in (% ) (2 .1) 7 .7 9.3 5.7 6.6

N et in te rest (332) (900) (1 ,135) (1 ,359) (1 ,976) D iv idend Payout R atio (% ) N M - - - -

P ro fit Befo re Tax 2 813 8,360 5,617 7,190 D ividend Y ie ld (% ) - - - - -

Tax (49) (174) (1 ,811) (1 ,217) (1 ,558) G R O W T H

N on-contro lling in te rests - - - - - R evenue (% ) 2.5 35.0 61.6 23.0 10.0

M odelw are N et Incom e (610) 3 ,055 5,969 4,494 5,752 EBITD A (% ) (45 .1) 170.9 79.5 (6 .6) 29.9

O ne-times and d isc ops, ne t 563 (2 ,416) 580 (94) (120) EBIT (% ) (117.1) N A 97.8 (18 .1) 32.6

N et Income, reported (47) 639 6,549 4,400 5,632 EPS (% ) (146.2) N A 95.4 (24 .7) 28.0

PER SH AR E LEVER AG E

M odelw are EPS (0.44) 2 .21 4.33 3.26 4.17 N et D ebt (mm) 27,346 25,684 25,337 33,734 49,076

R eported EPS (0.03) 0 .46 4.75 3.19 4.08 N et D ebt inc l. op leases (mm) 37,762 39,131 44,906 57,659 75,394

D PS - - - - - N et D ebt/Equ ity 1 .5 1.3 0.8 0.9 1.2

B ALAN C E SH EET N et D ebt/EB ITD A (inc. PD P) 9.2 3.2 1.9 2.7 3.0

C ash and equ iva lents 5 ,159 7,132 7,048 8,539 9,233 N et D ebt (inc. op leases)/EBITD AR 8.5 3.9 2.8 3.6 3.8

F inancia l Assets 1 ,393 929 1,229 1,229 1,229 N et D ebt/Enterprise va lue 0.5 0.5 0.5 0.6 0.7

Inventories and rece ivab les 2,097 2,961 5,308 6,527 7,180 R ET U R N S

Tangib le fixed assets 47,422 49,040 63,086 78,137 100,221 F ixed Asset Turnover (x) 0 .7 0.8 1.1 1.1 1.0

G oodwill and o ther in tang. 259 249 280 236 186 N et O p Asset Turnover (x) 0 .7 0.9 1.2 1.2 1.1

Associa tes 869 1,209 1,506 1,732 1,992 N O PAT M arg in (% ) (2 .6) 5 .2 8.2 4.9 6.2

Pension assets - - - - - R N O A (% ) (1 .9) 4 .4 10.2 6.0 6.6

O ther assets 7 ,875 7,127 14,624 15,688 15,837 R O E (% ) (3 .8) 16.0 23.2 13.4 14.9

T otal assets 65,074 68,647 93,081 112,089 135,878 R eturn on F in . Leverage (% ) (1 .9) 11.6 13.0 7.3 8.3

T rade and o ther payab les 2,534 3,813 6,237 7,887 8,474 C ASH C YC LE

ST and LT debt 36,048 34,198 36,303 46,191 62,226 Inventory D ays 9.3 6.6 7.1 7.1 7.1

Passenger fligh t liab ilites 2,803 3,831 10,783 13,259 14,584 D ays Sa les O utstand ing 16.3 20.2 22.7 22.7 22.7

O ther liab ilities 5 ,131 5,724 7,543 8,136 8,346 D ays Payab les O utstand ing (30.0) (36 .4) (38 .9) (38 .9) (38 .9)

Employee benefits 659 910 850 850 850 C ASH FLO W

Tota l liab ilities 47,175 48,476 61,716 76,323 94,481 Free C ash F low Ad j (m m ) (6 ,693) 7 ,808 4,272 (8 ,620) (15 ,610)

Shareho lders ' equity 17,899 20,171 31,365 35,765 41,397 FC F Y ie ld (% ) (75 .3) N A N A N A N A

N on-contro lling in te rests - - - - - C apex/Sa les (x) 9 .0 7.6 5.8 6.7 8.5

Liab ilities and SE 65,074 68,647 93,081 112,089 135,878 C apex/D eprecia tion (x) 0 .8 0.8 0.8 0.9 1.0

C ASH FLO W ST AT EM EN T

O perating C ash F low 829 8,274 16,503 12,644 13,411

C apex (fixed & in tang ib les) (2 ,651) (3 ,020) (3 ,701) (5 ,275) (7 ,366)

Acqu is itions/d ivestitu res, ne t - - - - -

O ther investing cash flow 1,894 6,041 (3 ,337) 57 712

Investing C ash F low (757) 3 ,021 (7 ,038) (5 ,217) (6 ,654)

C hange in ST and LT debt 4 ,476 (2 ,802) 5 ,972 - -

R epayment o f p rinc ipa l in finance lease liab . (1 ,971) (6 ,565) (15 ,520) (5 ,935) (6 ,063)

C ommon d iv idends pa id - - - - -

O ther financing cash flow (35) 45 (2) - -

Financing C ash F low 2,470 (9 ,322) (9 ,550) (5 ,935) (6 ,063)

Company data, Morgan Stanley Research, e = Morgan Stanley Research estimates

23

Exhibit 44: Pegasus: Key financial metrics, 2016-20eIn T R Y m m except per share data

IN C O M E ST AT EM EN T 2016 2017 2018e 2019e 2020e M AR G IN S 2016 2017 2018e 2019e 2020e

R evenue 3,707 5,349 8,111 10,119 10,854 G ross M arg in (% ) 5.3 14.5 14.1 11.2 12.0

EB IT D AR 556 1,308 1,804 1,999 2,348 EBITD A M arg in (% ) 2.4 13.7 12.5 9.5 10.5

EB IT D A 89 735 1,017 961 1,134 EBIT M arg in (% ) (3 .7) 7 .6 7.1 4.0 4.9

D eprecia tion and amortiza tion (227) (330) (440) (560) (606) N et In te rest M arg in (% ) 0.3 (3 .0) 0 .7 0.9 1.4

EB IT (137) 405 578 400 528 Effective Tax R ate (% ) 5.2 16.9 4.5 5.5 4.5

Share o f equ ity a /cs 3 4 6 7 8 N et Income M arg in (% ) (3 .6) 9 .4 5.2 3.0 3.5

O ther 4 32 (88) 10 11 D iv idend Payout R atio (% ) - - - - -

N et in te rest (13) 162 (60) (96) (156) D iv idend Y ie ld (% ) - - - - -

P ro fit be fore tax (144) 603 437 321 391 G R O W T H

Tax 7 (102) (20) (18) (18) R evenue (% ) 6.3 44.3 51.6 24.8 7.3

N et p ro fit fo r the year (134) 502 419 305 375 EBITD A (% ) (74.6) 721.7 38.4 (5 .6) 18.1

N on-contro lling in te rest 2 1 2 2 2 EBIT (% ) (177.4) N A 42.5 (30.7) 32.0

PER SH AR E EPS (% ) (236.7) N A (14.4) (36.7) 21.6

M W EPS (1.56) 4.63 3.97 2.51 3.06 LEVER AG E

R eported EPS (1.31) 4.91 4.10 2.99 3.67 N et D ebt (mm) 1,804 1,225 3,322 4,712 4,737

D PS - - - - - N et D ebt/Equ ity 1 .1 0.5 1.0 1.3 1.2

B ALAN C E SH EET N et D ebt/EBITD A 20.2 1.7 3.3 4.9 4.2

C ash and equ iva lents 692 1,988 1,677 1,529 1,845 N et debt/EB ITD AR 10.6 3.9 5.3 6.0 5.6

F inancia l investments - - - - - N et debt/Enterprise va lue 0.4 0.3 0.6 0.7 0.7

T rade rece ivab les and o ther rece ivab les 731 1,022 1,538 1,557 1,615 R ET U R N S

Inventories 24 31 63 81 87 F ixed Asset Turnover (x) 1 .2 1.3 1.3 1.2 1.1

Investments 24 29 36 43 51 N et O p Asset Turnover (x) 1 .2 1.2 1.3 1.2 1.1

Tang ib le assets 3,849 4,663 7,642 9,639 10,059 N O PAT M arg in (% ) (3 .7) 7 .6 7.1 4.0 4.9

In tang ib le assets 20 24 27 27 26 R N O A (% ) (4 .4) 9 .2 9.1 4.6 5.4

O ther rece ivab les and non-current assets 258 275 303 303 303 R O E (% ) (8 .8) 24.6 14.6 9.0 10.0

D eferred tax assets 7 - - - - R eturn on F in . Leverage (% ) 4.4 (9 .2) (9 .1 ) (4 .6 ) (5 .4 )

O ther assets 12 56 132 165 177 C ASH C YC LE

Assets he ld fo r sa le 24 29 36 43 51 Inventory D ays 2.5 2.4 3.3 3.3 3.3

T otal assets 5,618 8,088 11,420 13,345 14,162 D ays Sa les O utstand ing 20.6 12.6 13.0 13.0 13.0

T rade and o ther payab les 350 438 656 846 899 D ays Payab les O utstand ing 32.6 31.0 31.0 31.0 31.0

F inancia l liab ilities - 541 506 506 506 C ASH FLO W

O ther financia l liab ilities - - - - - Adj F ree C ash F low (m m ) (1 ,251) 719 (1 ,741) (1 ,295) 131

O bliga tions under finance leases 2,677 3,067 4,962 6,204 6,545 FC F Y ie ld (% ) (12.0) N A N A N A N A

Provis ions fo r employee benefits 468 723 919 919 919 C apex/Sa les (% ) (33.7) 13.4 (21.5) (12.8) 1 .2

O ther liab ilities 554 834 1,154 1,345 1,398 C apex/D eprecia tion (x) 5 .2 3.1 4.3 5.1 1.9

L iab ilities he ld fo r sa le - - - - -

Tota l liab ilities 4,049 5,603 8,197 9,820 10,267

Shareho lders ' equity 1,575 2,506 3,251 3,554 3,927

N on-contro lling in te rests (6) (21) (28) (30) (32)

Liab ilities and SE 5,618 8,088 11,420 13,345 14,162

C ASH FLO W ST AT EM EN T

O perating C ash F low 227 1,073 922 1,209 1,188

C apex (fixed & in tang ib les) (193) (168) (349) (511) (205)

Acqu is itions/d ivestitu res, ne t (4) (5) - - -

O ther investing cash flow (9) 830 (20) 177 81

Investing C ash F low (207) 657 (369) (335) (124)

C hange in ST and LT debt (251) (207) (1 ,013) (803) (480)

C hange in common equ ity - - - - -

C ommon d iv idends pa id - - - - -

O ther financing cash flow (48) (111) (193) (219) (268)

Financing C ash F low (299) (318) (1 ,206) (1 ,022) (748)

Source: Company data, Morgan Stanley Research, e = Morgan Stanley Research estimates

24

Valuation methodology and risks

TOASO.IS

Methodology:

We set our price target for Tofas at the average of our DCF analysis and target

multiples approach, to take into account both long-term and short-term trends. We

value the tax benefit from incentives and finance leasing separately.

Target multiple: 4.0x 2019e EBITDA below its LT average of 7x, given the slower growth

outlook (3% 2019-22e CAGR).

DCF: We use a WACC of 12.1% based on a CoE of 15.0%, a CoD of 4.0%, terminal growth

rate of 4% and gearing of 25%.

Key risks:

FROTO.IS


We set our price target for Ford Otosan at the average of our DCF analysis and target

multiples approach to take into account both long-term and short-term trends and tax

incentive benefits.


Better / worse than expected margin in 2018;

Higher / lower than expected Turkish auto demand and exports; and

FX and regulatory changes.

Better / worse than expected margin;

Higher / lower than expected Turkish auto demand and exports; and

FX and regulatory changes

Target multiple: 6.0x 2019e EBITDA, below LT average of 9x because of slower

volume growth (2% 2019-22e CAGR).

DCF: We use a WACC of 12.1% based on a CoE of 15.0%, a CoD of 3.2%, terminal

growth rate of 4.0% and gearing of 25%

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COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC) OTHER MATERIALINVESTMENT SERVICES

CLIENTS (MISC)STOCK RATINGCATEGORY

COUNT % OFTOTAL

COUNT % OFTOTAL IBC

% OFRATING

CATEGORY

COUNT % OFTOTAL

OTHERMISC

Overweight/Buy 1178 37% 308 42% 26% 562 40%Equal-weight/Hold 1378 44% 343 46% 25% 625 44%Not-Rated/Hold 49 2% 5 1% 10% 7 0%Underweight/Sell 554 18% 83 11% 15% 224 16%TOTAL 3,159 739 1418

Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investmentbanking compensation in the last 12 months. Due to rounding off of decimals, the percentages provided in the "% of total" column may not add up to exactly100 percent.Analyst Stock RatingsOverweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on arisk-adjusted basis, over the next 12-18 months.Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe,on a risk-adjusted basis, over the next 12-18 months.Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst'sindustry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on arisk-adjusted basis, over the next 12-18 months.Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.Analyst Industry ViewsAttractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broadmarket benchmark, as indicated below.In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad marketbenchmark, as indicated below.Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad marketbenchmark, as indicated below.Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe -MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index.Stock Price, Price Target and Rating History (See Rating Definitions)

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INDUSTRY COVERAGE: EEMEA Transport

COMPANY (TICKER) RATING (AS OF) PRICE* (10/15/2018)

Nida IqbalAir Arabia PJSC (AIRA.DU) E (03/24/2017) AED 0.95DP World (DPW.DI) O (11/26/2014) US$18.25Pegasus Hava Tasimaciligi AS (PGSUS.IS) U (10/15/2018) TL 24.82TAV Havalimanlari Holding AS (TAVHL.IS) U (08/01/2018) TL 27.76Turkish Airlines (THYAO.IS) U (10/15/2018) TL 17.49

Stock Ratings are subject to change. Please see latest research for each company.* Historical prices are not split adjusted.

© 2018 Morgan Stanley

33

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EEMEA Transport | Europe · [email protected] [email protected] No Rating MORGAN STANLEY & CO INTERNATIONAL PLC (DIFC BRANCH)+ Nida Iqbal EQUITY ANALYST