IAG: Delicately Balancing
its Finances Mar/Apr 2022

IAG had entered the crisis with a relatively healthy balance sheet: a net debt to EBITDA ratio of 1.4x, well below its target ceiling of 1.8x, liquidity of €9bn (36% of 2019 annual revenues), and investment grade ratings. And, importantly, it had built in a high degree of flexibility with only one third of its 598 strong aircraft fleet owned and two thirds on operating lease.

It paid for the losses by raising both debt and equity. Total debt at the end of 2021 stood at €19bn, €5.4bn (37%) higher than at the end of 2019. It raised €2.7bn from shareholders in an emergency, and dilutive, rights issue in the second half of 2020.

It benefited from generally available government support through the crisis. These included the various job retention schemes in the UK, Ireland and Spain giving a benefit to the wage bill of €558m, as well as state backed loans and loan guarantees from Ireland’s Strategic Investment Fund, Spain’s ICO, and under the UK Export Development Guarantee.

But, unlike its arch rivals Air France-KLM and the Lufthansa Group, it managed to survive without the need to request specific state aid from any of its airlines' governments (not that any help would realistically have been likely to have been forthcoming from the UK for British Airways) and as such avoided the concomitant management, operational and competitive restrictions.

Source: Company reports; forecasts Bernstein

Future size and shape

Two years on from the onset of the Covid-19 pandemic and the Group is a lot smaller.

IAG disposed of 85 aircraft over the two years, including an accelerated retirement of British Airways' remaining 32 ancient 747s and Iberia’s 15 fuel-guzzling A340s (the other four-engined aircraft, BA’s 12 A380s, were put into storage temporarily — they will still be needed at the slot-constrained Heathrow).

It also got rid of a lot of employees: 25% of the workforce at BA and 10% at Aer Lingus (Iberia and Vueling were restricted from laying people off under the terms of Spain’s ERTE wage support programme). Total employees, in manpower equivalents, fell by a quarter from 66,034 in 2019 to 50,222 in 2021.

It had been planning its fleet renewal process as part of its necessary path to net-zero. At the group’s last Capital Markets' Day (CMD), which was way back in 2019, the group highlighted its then fleet plan, suggesting it had ironed out the spikes in aircraft replacement that had been a traditional feature of the old British Airways and had in place a smooth transition to next generation aircraft.

For 2020-22 it had at that time anticipated taking delivery of 92 short haul and 51 long haul aircraft to provide replacement and growth, and from 2023 it foresaw a need for 217 short haul units (including an early replacement of A320ceos) and 66 long haul aircraft for replacement, evenly spaced over the years to 2029.

It was inevitable that IAG renegotiated scheduled deliveries during the crisis — not merely to halt the arrival of aircraft with nowhere to fly, but more importantly to stem the outflow of cash in capex. The chart shows the evolution of those plans from the CMD projections, through those promulgated at the time of the capital raising in 2020, to the current plans presented at the announcement of the 2021 full year results in February 2022. In the end IAG took delivery of 45 aircraft in 2021 and 2022, half that originally planned leaving a group fleet at the end of 2021 (see table) some 20% smaller than two years previously.

	Dec 2019	Δ	Dec 2021	Orders	Options
E170	6	(6)
E190	18	5	23
Regional	24	(1)	23
A318	1	(1)
A319	57	(18)	39
A320	254	(14)	240	22	76
A321	66	7	73	34	14
Narrowbodies	378	(26)	352	56	90
A330-200	24	(6)	18
A330-300	16	2	18
A340-600	15	(15)
A350	9	8	17	26	52
A380	12		12
747-400	32	(32)
777-200	46	(3)	43
777-300	12	4	16
777-9				18	24
787-8	12		12
787-9	18		18
787-10		2	2	10	6
Widebodies	196	(40)	156	54	82
TOTAL FLEET	598	(67)	531	110	172

The chart shows the associated data for group capital expenditure. Gross capex turned out at €2.6bn, 70% less than that planned for the years in 2019. Net of asset sales, capex in 2021 fell to a mere €200m (partly as a result of delivery delays from both main manufacturers).

This reduction in capex helped. Some recovery in operations had already been experienced in the second half of 2021. This was particularly so for Iberia and Vueling, both having the benefit of a substantial domestic market and fewer restrictions on travel. For 2021 as a whole Iberia operated capacity at 65% of 2019 levels and Vueling at 63%. By contrast BA, with the Atlantic then still effectively closed, operated at 28% of its 2019 capacity and Aer Lingus at 24%.

In the fourth quarter IAG reported the first quarterly positive EBITDA result (of €250m) since the start of the pandemic, despite the impact of the omicron variant of the virus (Iberia even posted an operating profit of €82m in period, a margin of 8%). For the second half of the year as a whole the group achieved positive operational cashflow of €1bn.

The group ended 2021 with a high level of liquidity at €12bn (including €4bn in undrawn facilities) up by nearly €2bn over the year and the highest since the start of the pandemic. CEO Luis Gallego expressed some satisfaction that net debt had fallen to a mere €11.7bn from €12.5bn at the end of September 2021.

At the results announcement in February the group indicated that there would be a ramp-up in capacity as markets opened, aiming to recover capacity in 2022 to 85% of that flown in 2019. By the peak third quarter it expected to be flying only 10% less than pre-pandemic levels, with operations on BA’s key Atlantic routes back to the levels of three years ago, and South Atlantic operations out of Madrid back to 95% of former capacity by the fourth quarter.

With encouraging forward bookings, the company guided to a “significant” operational cash flow and operating profit for the full year (although the first quarter would be strongly negative because of seasonality and the cost of ramping up operations).

War risk

But that was before the Russian invasion of Ukraine, the resulting economic war of sanctions pursued by the US and Western Europe against the aggressor, closure of Russian airspace to “unfriendly nations” and the pressure on fuel prices.

IAG as a group has relatively little exposure to the removal of the right to overfly Russian airspace. Its operations into Russia (or Ukraine) are a minuscule part of its network. It (through British Airways) is the fifth largest operator on the markets between Europe and Asia Pacific (well behind Lufthansa and Air France-KLM) with less than 6% of total market revenues in normal times. Furthermore, less than a third of its operations to the Asia Pacific region involve flights to North East Asian destinations which would be subject to the longest diversions away from Russian airspace.

The war in Ukraine could affect peak summer season passenger traffic demand on the Atlantic just at the time that the market reopens after two years of effective closure: outbound US leisure travel tends to be affected by such geopolitical events.

Of perhaps more concern is the economic impact. Significant inflation in fuel, commodities and food prices will add pressure to economic growth and personal incomes: not a good environment for encouraging air travel growth, however much the level of pent-up demand may be.

	British Airways (£m)		Iberia (€m)		Vueling (€m)		Aer Lingus (€m)
	2021	Δ v 2019	2021	Δ v 2019	2021	Δ v 2019	2021	Δ v 2019
Passenger Revenue	2,316	-81%	1,724	-58%	1,011	-59%	308	-85%
Cargo Revenue	1,097	+54%	394	+35%			65	+20%
Other Revenue	281	-59%	666	-49%	5	-72%	4	-64%
Total Revenue	3,694	-72%	2,784	-51%	1,016	-59%	377	-82%
Costs	5,594	-51%	3,018	-41%	1,278	-42%	724	-61%
Operating result	(1,900)	(3,821)	(234)	(731)	(262)	(502)	(347)	(623)
Margin	-51%	-66pts	-8%	-17pts	-26%	-36pts	-92%	-105pts
ASK(m)	52,633	-72%	40,606	-45%	20,355	-47%	7,380	-76%
RPK(m)	30,698	-80%	27,976	-56%	15,554	-53%	3,545	-86%
Load Factor	58%	-25pts	69%	-18pts	76%	-11pts	48%	-34pts
Sector length (km)	3,205	1%	2,620	-8%	986	4%	1,800	-11%

Another rights issue needed?

On the publication of the full year results in February, the stock markets appeared unimpressed, worried that capital expenditure plans were too high. IAG said it was targeting spend of €3.9bn in 2022 up from the €2.4bn it had earlier earmarked. In fairness, the increase is probably a natural consequence of the delivery delays experienced in 2021 and a restart of predelivery payments for rescheduled aircraft delivery programmes. It is also, as the group states, “reflecting the need to re-build capacity towards pre-pandemic levels”.

Along with a build-up of capital expenditure, there has been a massive increase in long term debt — to €17.1bn at the end of 2021. IAG’s CFO, Steve Gunning, appeared relaxed with the €12bn in liquidity he has secured (equating to nearly 50% of what had been 2019’s annual revenues) and sanguine about the debt repayment schedule (see chart), saying it was “manageable”. But with the publication of the results in February he stepped down from the role and the group, leaving the headache for his successor.

A large portion of the repayment schedule relates to unsecured corporate debt, and repayments average €600m a year over the next three years. But the 70% state-guaranteed €1bn ICO loan organised by Spain’s Official Credit Institute in May 2020 in favour of Iberia and Vueling (repayable 2023-2025) has non-financial restrictions against “upstreaming” of cash to other IAG Group companies, and the 80% guaranteed UKEF organised £2bn loan to British Airways becomes fully payable in 2025 (there is an additional undrawn £1bn facility available).

In the chart we show an estimate of the level of capex in the next few years along with a range of estimates from two respected equity analysts for EBITDA as a proxy for cash generation. The latter relies on underlying assumptions on restoring revenues and suggests that 2022 and 2023 could still be difficult years on the path to recovery.

Notes: Capex forecast Bernstein. EBITDA forecast range Bernstein and HSBC

The emergency rights issue in 2020 was done in extremis. Ideally IAG might want to wait until there is a clear path to profitability before calling on shareholders again so that it doesn’t impose further dilution. But if it doesn’t raise new funds, it might take a very long time to restore the balance sheet to a healthy state. At the end of 2021 net equity officially stood at only €846m. Excluding intangible assets, it would be negative to the tune of €(2.15)bn.