Are the Euro-Majors undervalued? November 2002

Can Europe’s major airlines be worth as little as the stock–markets are showing? Although there was a noticeable upturn in values towards the end of October, the share prices of the Euro–majors have been languishing badly. Deutsche Bank, in a recent report, has calculated that these airline stocks in October were trading at price to book value ratios that were roughly half those of previous troughs.

Another indicator is the net asset value per share (net assets adjusted to market values) which are shown in the table below. Air France, Lufthansa and KLM’s stocks are being quoted at well under the values implied by the underlying assets; the opposite is true for BA, unfortunately.

The obvious reasons are the continuing slump in traffic and yields, the depression drifting over the Atlantic from the US majors and the impending threat of war in Iraq.

The much sought–after statistic in the upcoming months is positive traffic growth compared to the equivalent period in 2000. In September, Air France, Lufthansa and KLM produced traffic numbers 5–7% above 2001, but still 0–3% below those of 2000. BA’s traffic results are not particularly relevant because of its downsizing strategy, but September’s RPKs were 5% up on 2001, 16% down on 2000.

Yet the four leading European carriers are in a much stronger position than their US equivalents. They all appear to have sustainable market positions, and are not under immediate threat, unlike United, US Airways or even American. KLM has dismissed reports of a merger with Air France but has talked about much closer cooperation.

In terms of the state of their balance sheet strength at this phase of the cycle, Lufthansa and Air France look very solid; BA appears weak — with a net debt/equity ratio of 354% — but its liquidity is strong.

Deutsche Bank’s view of the airline’s profitability also provides a bit of comfort. For 2002 Lufthansa is expected to return robustly to profit, Air France to maintain its profitability while BA and KLM are to greatly reduce their losses.

BA’s second quarter (July–September) results — an expected pre–tax profit of £245m or €390m — are a huge improvement on last year’s £5m, and provide some evidence that BA’s "Future Shape and Size" strategy may be working, at least in parts. Given that BA has already faced the low–cost carrier onslaught, which Lufthansa will be the next to experience, and that its profitability is so geared to the Atlantic market, perhaps its financial prospects relative to its continental competitors are rather better than indicated by the stock–markets.