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IAG: Contrast with other European Majors May 2015 Download PDF

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IAG is diverging further from its rivals, Air France-KLM and the Lufthansa Group. In 2014 the group produced an operating profit of €1.4bn and a net result of €1bn; for 2015 IAG is indicating an operating profit of €2bn. By contrast Air France-KLM lost €189m net while Lufthansa was just above break-even with a €55m profit.

IAG’s stock price has soared over the past two years while those of the other two Euro-majors have gone in the opposite direction. Although the smallest of the Euro-majors in terms of revenues, IAG is rated as being worth €16.1bn, Lufthansa at €5.9bn and AF-KLM at €2.7bn

Economic fundamentals favour IAG. UK GDP growth was 2.6% last year and is expected to be 2.7% in 2015 according to the IMF. Spain is recovering: 1.4% growth last year, 2.5% this year. Germany is weaker, 1.6% for both years, while France is faltering, 0.4% in 2014, 1.2% in 2015.

Labour relations appear harmonious at BA at the moment and even the rationalisation processes at Iberia have proceeded as smoothly as could have been expected (which of course could change very quickly). By contrast Air France management have been bogged down in negotiations with its flying and maintenance staff, and Lufthansa have been beset with pilot strikes in opposition to pension changes. One of the problems that Air France has in particular is that inescapable non-progressive social charges are added to gross salaries in France, pushing up average labour costs by 25-30%. The comparative figure for the UK is about 5% (incidentally in the Netherlands it is zero).

In Vueling IAG has a dynamic low cost airline which is proving capable of competing with Ryanair in new markets, its Rome base for example, and which is actually the best performer in terms of operating profit and return on capital within the IAG group (see table, page 2). By contrast Lufthansa is faced with expansion by both EasyJet and Ryanair in its domestic market, expansion which will accelerate as airBerlin retrenches further. Lufthansa somehow has to restructure Germanwings into a lower cost Eurowings in order retain control over domestic feed which is iessential for its global hub system. Air France has had to abandon its project to develop Transavia into a Europe-wide low cost subsidiary in the face of union opposition.

For 2015 Vueling’s capacity growth (ASKs) will be around 15.6% compared to 10.4% for Iberia and just 2.4% for BA. Indeed in its key market — the North Atlantic — BA is hardly growing at all, ASKs up by 0.5% in the first quarter, but unit revenues are very strong up by 5% despite the falling fuel prices (in all other segments IAG’s unit revenues fell so the group-wide decline was 1%). The North Atlantic is where the three Euro-Majors have established oligopolistic or quasi monopolistic markets, operating as virtually the same airlines as their three US partners. Willie Walsh is probably understating the situation when he describes the North Atlantic as “very healthy”.

Certainly, IAG does not share the other Euro-majors’ abhorrence of competition from the Gulf super-connectors, the opposite in fact, and not just because of its 10% ownership by Qatar Airways. The Heathrow hub is very different from those at Frankfurt and CDG. BA is nowhere near as reliant on connecting flows as the other Euro-majors and can exploit the congestion at Heathrow by using growth to replace connecting passengers with high-yielding direct passengers (ten of the top international O&D routes involve Heathrow). And if slots are required BA can usually obtain then through slot trading or adjusting its own schedules — Willie Walsh made this point to the Irish parliamentarians, defusing the argument that IAG’s interest in Aer Lingus was to get hold of its scarce Heathrow slots. In terms of domestic networks, BA again is in a different situation to Lufthansa or Air France. Emirates' operations to UK regional cities like Manchester or Newcastle tend to divert traffic away from the European continental hubs rather than from London.

IAG’s principal long-haul expansion is now on the South Atlantic where Iberia, with a revamped product, has reinstated routes that where dropped or downgraded during the depths of the Spanish financial and economic crisis — Montevideo, Santo Domingo, Havana, Mexico City and Panama. Air Europa too has announced a substantial South American growth plan, but IAG is unconcerned with Willie Walsh claiming out that Air France, which has admitted to serious losses on the South Atlantic, cannot compete against Iberia in this sector.

IAG appears to have positioned itself well to develop new intercontinental alliances. With Qatar BA has already outsourced its long-haul cargo operation, and a joint venture funnelling traffic into the Indian sub-continent, southeast Asia and China would appear attractive, though American, with its support for the US fair Skies campaign (see pages 8-14) is posing a diplomatic problem at present. Latam (see pages 15-18) promises to be a candidate for some form of integration into the IAG group at some point, particularly as its European services are relatively limited.

Meanwhile, the Aer Lingus purchase is close to completion. At the end of May the Irish parliament finally approved the sale of the government’s stake in return for some more guarantees on LHR slots, leaving Ryanair to divest its share (which it almost certainly will). The price for Aer Lingus is about €1.4bn but that includes €600m of net cash. This seems to be a very good deal for IAG which has in effect bought not just a profitable €1.7bn-revenue airline but also gained a new runway.

IAG Returns by Unit
Capital allocation RoIC Op Margin
BA 71% 8.5% 7.9%
Iberia 20% 5.5% 4.8%
Vueling 9% 13.1% 12.1%
IAG 100% 8.4% 7.8%
Notes: capital allocation as at Q1 2015, RoIC and Op. Margin for last four quarters. Op. Margin adjusted for inflation
European Majors' Share Price Performance
European Majors' Share Price Performance Produced by GNUPLOT 4.6 patchlevel 5 75 100 125 150 200 300 400 2013 2014 Indexed (1 Jan 2013=100, log scale) gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 IAG Lufthansa Air France-KLM 2005

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