Cookie Consent

This site uses cookies for functionality. To see our cookie policy click here.

If you continue to use this site we will assume that you are happy with this.

IAG: BA surging ahead, dragging Iberia with it November 2013 Download PDF

Cloud Image

International Airlines Group’s annual capital markets day in the middle of November presented mostly positive comments and, unlike other recent announcements from the other European airlines, contained no overt or veiled profit warnings. The group increased its headline target for operating profits in 2015 by over 10% to €1.8bn although the underlying target of achieving a 12% return on capital remains unchanged.

This upgrade in the group’s targets come mainly from a strong performance by the British Airways operating unit in the current year and the impact of the acquisition of Vueling. The group implicitly expects that the improvement in margins seen this year at BA will continue through the next two years: the group increased its estimate for BA’s operating profit in 2015 from £1.1bn to £1.3bn (with an expected profit this year of £700m). It has also added a contribution to arise from growth at and Vueling. In contrast, while saying that the Iberia restructuring plan is on track, it has in effect forecast a lower operating performance from the Spanish flag-carrier by 2015 than it had proposed in last year’s capital markets presentation.

The group’s financial targets have not really changed. It is aiming to have a business model that can sustain organic growth levels (excluding Vueling) of 2-3% a year, and which provide returns to shareholders (with luck and a following wind) in excess of cost of capital. It appears to be expecting operating profits of €740m in the current year, so to reach its target will need to improve earnings by €1.1bn in the next two years.

There are four main planks to the strategic financial plan over the next two years:

  • “Transform Spain” to bring Iberia back into profit and a sustainable growth path;
  • “Transform London” to improve performance at BA through sustainable increased unit revenue performance;
  • Extract further synergies from the combined group; and
  • Allow for growth potential at BA and Vueling.

Each of the first two planks are expected to generate improvements in operating profits of around €400m (each postulated with €100-€150m upside potential). The group once again has increased its estimate of future synergies arising from the merger of BA and IB and suggests that now it may achieve additional revenue benefits and cost reductions of around €190m over the next two years. On top of this it is allocating around €200m from growth at both BA and Vueling. If that upside potential at BA and IB were realised the target for 2015 could easily reach a €2bn operating profit.

Synergies — new target €600m net EBIT impact

When the BA/IB merger was first announced the companies estimated combined synergies of €400m by 2015. Last year at this time the group estimated the figure at €560m and now has upgraded it to €650m with a net operating impact of €600m. Roughly half of the synergy contribution comes from reduced costs and the other half from improved revenues. Of course the management’s statement of synergies can never be confirmed independently from published accounts, but the group does state that in 2013:

  • Net additional revenues reached €66m and cost reductions touched €56m giving an annual benefit of €122m;
  • The group began outsourcing transactional functions;
  • Sales outlets have now been integrated in 19 locations, with Portugal, Morocco, Israel and the Nordic counties integrated in 2013;
  • Seven major European airport ground handling contracts have been renegotiated;
  • 19 new code share routes (with Buenos Aires, Rio and Sao Paolo prominent performers) have been implemented, giving 58 total code share routes;
  • A new long- and short-haul Group fleet order secured additional discounts from the manufacturers, in effect providing savings of €20m-€30m a year.

Fleet Plans

Last year the group announced its intention of reducing its total fleet from 380 units to 358 by the end of 2015, mostly through cutting back short haul operations at Iberia as part of its planned restructuring. The acquisition of Vueling added over 50 A320s to the group fleet and has radically changed the short haul growth prospect.

BA is gradually renewing its long haul fleet. It now has three A380s and four 787s in service with another six and eight respectively to be delivered in the next two years. These are replacing the ageing 747s and 767s, creating a modest increase in average long haul gauge. At the same time it is disposing of its 737 Classics (particularly at Gatwick) as more A320s are delivered.

Iberia continues to take on new A330s on lease (as an interim measure until the A350 comes on stream) gradually replacing the fuel-hungry A340s. Vueling has plans to expand its current fleet of 59 A320s to 100 in the next two years.

Overall, the group appears to be planning an average annual growth of 6.6% in capacity (in ASK terms) over the next two years (4.9% pa excluding Vueling). The 100 aircraft on order for delivery between 2016 and 2022 are primarily to secure fleet replacement; the additional 170 options over that period could generate long term growth of 5% a year in an upside case.

The group has adjusted the timing of its capital expenditure programme over the next few years, but has retained its plan of an average spend of €2bn a year. This neatly fits in with the group’s financial targets for 2015 of a 12% return on capital (just above its estimated 10% weighted average cost of capital); roughly two thirds of the spending is needed for replacement of existing equipment and one third to help generate long term growth of 3% a year. As a result of the acquisition of Vueling, it has slightly increased its gearing targets: debt (including leases) of between 50-60% of total capital, with ratios of net debt and gross debt to EBITDA of three and four times respectively. It is also targeting investment grade for the individual airlines; this may be easier for BA to achieve than the other two.

Q3 Results

In the three months to end September 2013 group revenues were up 7% on the back of a 9% increase in passenger capacity and traffic. A 1% increase in passenger unit revenues was offset by a 14% drop in cargo and other revenues. In constant currency terms passenger unit revenue increased on a like-for-like basis by 7.4%, specifically reflecting the bounce back from a poor quarter for BAn the prior year period (the result of the London 2012 Summer Olympics, a negative €100m effect on revenues).

For the group, operating profits came in at €690m before exceptional items, against €270m in the prior year period. Of this BA provided €407m, Iberia €74m (up from break even in the prior year period) and Vueling (included for the first time) €139m. Total group unit costs fell by 10% year on year, although this was largely because of Vueling; unit costs excluding fuel at both BA and Iberia increased by 1%.

For the nine months to end September total group operating profits came in at €657m, hugely up from €17m in the previous year, and even 50% higher than the level achieved in the same period in 2011. For the full year IAG expects to be able to produce operating profits of €740m (still less than half of the level it needs to achieve to generate returns above the cost of capital). Mildly disturbingly, the group stated that it expected growth in 2014 to be driven by “volume” rather than revenue as BA launches new long haul routes and as a result of the continued expansion at Vueling.

BA — Transforming London

Heathrow looks as if it is returning to be the power house of profits for BA. Management stated that it is well ahead of its original plans for 2013 and has raised its targets for 2015 by £200m to aim for operating profits of £1.3bn (nearly twice this year’s expected result of £700m).

One of the main drivers behind this was the “transformational change” arising from the acquisition of bmi and its slug of slots at Heathrow. At a stroke this allowed BA to capture over 50% of the slot base, recover some short haul point-to-point and feed services which it had had to forego in previous years in favour of long haul, and allow it room to introduce new (and sometimes reintroduce old) long haul services. The company had originally estimated that the bmi integration would have had a mildly negative impact on the current year’s profitability with a first half loss of around £50m and a second half break even. It now estimates that it has actually had neutral effect in the first half of the year and in the second half will generate a contribution of more than £30m. In total, short haul revenues are some £120m better than anticipated.

The increase in the target for 2015 comes partly from the better than expected performance in 2013. The airline is expecting:

  • Non fuel unit costs to fall by 1% in 2014 in constant exchange rates and be flat in 2015 generating an additional £70m net impact (although this depends on the final decision about the regulatory charging structure at Heathrow);
  • Fleet replacement programme to generate £140m net savings (mostly fuel) as the new generation aircraft are delivered;
  • Network and product: the company expects that it will be able to retain and continue to gain additional unit revenue benefits with expectations of a 1-2% increase a year in terms of revenue per ASK — this could produce additional profit of £100-150m on short haul operations and £150-200m on long haul, £130m higher in total than the company had originally targeted;
  • In 2015 it will consolidate all the T1 operations into T3 (following the bmi purchase, the airline is operating at three terminals at Heathrow), which will allow it to “unlock” the right aircraft on the right route and to improve customer service.

The company states that it has an overall aim of generating returns in excess of its 10% pre-tax cost of capital at each of the three London airports — Heathrow, Gatwick and London City — and for both long haul and short haul. It does not normally provide airport-level information in detail, so for outside observers success will be difficult to corroborate.

However, perhaps disturbingly, it appears that there will be a somewhat higher overall growth in BA’s capacity of 6% in 2014 compared with the average 2-3% medium term target and near flat growth this year. (This is somewhat similar to the growth plans at Lufthansa for next year — see Aviation Strategy October 2013). However, the company explained it almost rationally and the core network growth is seen at 2.8% — almost entirely long haul (see chart above).

On short haul operations BA did say that it expects to break even in the current year compared with a loss of £120m in 2012 and implied that it is aiming to generate profits in this sector of £150m within two years. It may be able to do this. Overall capacity growth in this sector is set to be up by only 0.5% in 2014. It is focusing on point to point services while maintaining the transfer rate at LHR and improving connection potentials at LGW (without emphasising that airport as a hub). It will be removing the last of the 737 Classics from the fleet in 2014 leaving a short haul fleet almost entirely consisting of A320s at LHR and LGW, and Embraers at LCY. At LCY, BA is now the largest operator, and is benefiting from the weak competition provided by financially challenged Air France affiliate CityJet.

Joint Ventures

As usual it is difficult getting precise figures on the performance of the joint ventures. On the Atlantic “Joint Business” with American, Iberia and Finnair, BA stated that in the three years since launch it had seen:

  • Overall capacity up by 12.5% (or an average 4% pa);
  • Revenue increase of 31.5% and unit revenue improvement of 17%;
  • An improvement in premium market share of over three percentage points, and in premium load factor of nearly seven points;
  • A one point increase in non-premium market share.

The company also highlighted that two of the new routes it will be operating next year (to San Diego and Austin, Texas) were only made possible because of the immunised joint venture with American.

There was little comment on its “Siberian JV” with JAL and Finnair except that it was generating revenue benefits especially in code shares through Narita and Haneda (although probably not hugely significant given the weakness of the yen). Management hinted that with LATAM plumping to join oneworld (TAM and LAN Columbia join the GBA in March 2014) there might be an opportunity to develop a JV on the South Atlantic. It still trying to find a partner in China.

Joint ventures are not necessarily immutable. After Qantas shifted allegiance to Emirates and dissolved the long established JV with BA on the Kangaroo route, BA stated that it had been able significantly to improve returns on the route: it cut capacity by 11% and saw unit revenues jump by 29%.

Iberia — Transforming Spain

The new Iberia CEO, Luis Gallego, gave a fairly convincing presentation on how he will transform the dinosaur of the Spanish flag carrier and achieve reasonable levels of profitability, even if it might not quite get there by 2015. At the capital markets day last year, Iberia had stated that its priority objectives were to stop operating cash burn by mid 2013, build a competitive cost base for the long term and to fund the transformation entirely from within its own resources.

Between 2008 and 2012 Iberia had seen its cash pile of €2.9bn shrink to €808m with losses over the period of €800m, fleet spending of €700m and early retirement package payments of €600m. With a return to a little better than break-even in the summer it might have been able to halt the cash outflow, but there is obviously a long way to go to turn the business around.

In 2013 the company drastically restructured its network operations. It cut some 17 short haul and four long haul routes from its network (along with 20 short haul and three long haul aircraft from its fleet). Route optimisation targeted unprofitable short haul routes with limited feed potential and the long haul routes that were unprofitable and had no strategic fit, resulting in an overall 15% reduction in capacity.

That was the easy bit. One of the big difficulties is dealing with the uncompetitive cost structure, employment levels and bloated legacy edifice. It is not necessarily that its unit costs are too high in comparison with peers — ex-fuel unit costs are in fact some 10% below peers on long haul and 15% below legacy peers on short haul — but being based at the bottom of an inbound tourist well it is competing on routes where the unit revenues are significantly lower. It is this gap between RASK and CASK that causes the damage. Attempts to restructure the staffing levels and short haul operations have been fraught with legal restrictions. Iberia Express was launched two years ago designed to be a lower cost and more efficient short haul operator than the main line. This led to union action and a government-imposed arbitration procedure which generated a judicial resolution (“laudo ”) that significantly limited Iberia Express’ activities. Iberia appealed against the judgement as well as a new laudo with similar restrictions. After the announcement of the new restructuring plan in 2012 and a lack of agreement with unions, Iberia unilaterally initiated collective dismissal procedures, which again led to strikes but this time a voluntary mediation agreement signed by the company and a majority of employees.

The mediation agreement did not quite go as far as Iberia wanted but allowed for over 3,000 redundancies (or 15% of the workforce); a 14% cut in salaries for pilots and cabin crew and a 7% reduction for ground staff; an additional 4% wage cut until productivity measures are agreed; salary and tenure freeze until 2015. So far the company has shed 2,300 out of 20,600 jobs (excluding some 130 natural wastage). It is currently in negotiations with the unions for long term agreements to obtain significant productivity improvements for the existing flight and cabin crew, introduce new salary scales and remove the imposed restrictions on Iberia Express.

Commercial turnaround

Just cutting costs will not be good enough and the company outlined some of the elements it has in place to try to transform the Iberia product, customer experience and revenue generation.

The Iberia long haul product was recognised to be a bit “tired” with sub-standard business class and economy offering on long haul leading to a low overall customer satisfaction in comparison with major peers. At the beginning of 2013 the company started rolling out a new generation full-flat business class seat on long haul and significantly upgraded economy product including the now standard individual IFE on its new A330s. It has already seen a strong increase in customer satisfaction on the new aircraft and this new in-flight product will be fitted on the eight new A330s to and will be retrofitted on the 17 existing A340s.

The company is introducing some profound changes in revenue management. Iberia had some surprising procedures; last year were we told about a habit of emphasising loss-making short-haul to short-haul connections. This year we discover that they had had such a rigid approach to high season bookings that overall there was only a 5% differential between high and low season yields, while they also had far too many FFP redemption seats available on too many of the routes which normally have over 90% load factors. Changing the approach has resulted in positive unit revenue performance of 2.5% in Q2 2013 and 6% in the summer season.

One of the biggest changes is the introduction of a new brand identity and paint scheme — last changed in 1977. Naturally the brand launch comes with the usual marketing gobbledegook: “... represents our core values Afinidad, Empuju, Talento ” and is designed to emphasise the Spanish nature of the brand. Iberia in part is using this as a catalyst (as BA itself has done in the past) to invigorate and change the corporate culture. It will be imposing a radical transformation in its management team: slimming down with a significant reduction in numbers and a new management style, simplification of the organisation structure with fewer reporting levels and a drive to recruit additional skills from outside the existing company.

Vueling — emphasis on cost discipline

Alex Cruz, CEO of Vueling, gave a presentation on the group’s newly acquired LCC. He emphasised the vision:

  • Cost discipline: targeting unit costs ex fuel below €4c/ASK in the short run, with a continuing annual cost savings programme
  • Profitable growth: with a current fleet of 70 A320s it has plans to expand to over 100 aircraft in 2015. It is increasingly focusing on non-Spanish markets and aims to expand market presence at key European airports. It helps to be market leader in Barcelona with a 36% share.
  • Product and innovation: a hybrid LCC with “business-class” seating in the front four rows of the aircraft, preferring main airports (and avoiding direct competition with Ryanair) and providing multiple sales channels. With a strong O&D network in Barcelona, it also prides itself on operating a “profitable and sustainable model of transfer passengers” — with over 11% of the total passengers connecting between Vueling flights in 2013 (16% of the Barcelona traffic) — while not shying away from (profitable) interline and code share agreements.
  • Efficient operation: Quick turnaround, high utilisation, single aircraft type, high punctuality. It states it achieves 90% customer recommendation levels.

Vueling is growing very strongly. It has doubled the size of its operation in the last five years and now operates 70 aircraft and carries 17m passengers (12m through Barcelona) on 222 routes connecting 107 destinations in Europe. It prides itself on having achieved an operating profit in each of the past five years (although profits fell from €2m per aircraft in 2009 to €0.5m per aircraft in 2012). This year it is expanding capacity and traffic by 25% year on year and has 62 A320s on order with 58 options. Despite its size and its hybrid business model it has an underlying ex fuel unit cost not too dissimilar from either easyJet or norwegian.

It is of course above Ryanair, which just annouced new bases at Brussels Zaventem and Rome Fiumicino directly competing with Vueling.

One of the major benefits to Vueling from being within the IAG stable should be in cost of aircraft ownership. All its fleet is leased and, although no doubt arranged on the best terms it could achieve, the company should be able to use the holding Group’s balance sheet and negotiation power to reduce the net input cost.


All the three major network groups in Europe are essentially pursuing the same strategy — to return to a reasonable level of profitability in 2015 that more than covers the cost of capital. Each needs to recover profitability on short haul operations which have seen severely negative results in the past few years. Each is pursuing similar methods, in particular trying to keep capacity growth low. There are some concerns that this “discipline” may slip a little for different reasons in 2014. IAG has one major benefit in comparison with either LHAG or Air France-KLM: BA’s base at London Heathrow with its vastly superior O&D point to point traffic base. The IAG team gave a convincingly encouraging view that the group will achieve its 2015 targets.

IAG Fleet Plans
Post 2015
Aircraft 2012 2013 2015


Orders Options
A330 / 340 33 29 30 29 8
A350 0 0 0 18 50
A380 3 9 9 3 7
747 52 49 39 43
767 14 12 7 7
777 52 54 58 58
787 4 12 12 30 18
A318 2 2 2 2
Total long haul 153 153 157 160 51 83
A320 family 187 227 282 172 52 158
Other 40 39 17 26 12
Total short haul 227 266 299 198 52 170
Total fleet 380 419 456 358 103 253
* Change from 2012 plans
IAG Synergy Targets
IAG Synergy Targets Produced by GNUPLOT 4.6 patchlevel 1 0 100 200 300 400 500 600 700 2011 2012 2013 2014 2015 EURm gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 Costs Revenues Original Targets Net EBIT Impact
IAG Traffic & Capacity 2013
IAG Traffic & Capacity 2013 Produced by GNUPLOT 4.6 patchlevel 1 -30% -20% -10% 0% 10% 20% 30% 40% Jan Feb Mar Apr May Jun Jul Aug Sep Oct gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 gnuplot_plot_5 gnuplot_plot_6 BA ASK BA RPK IB ASK IB RPK VY ASK VY RPK
IAG Operating profits
IAG Operating profits Produced by GNUPLOT 4.6 patchlevel 1 -1,000 -500 0 500 1,000 1,500 2,000 2007 2008 2009 2010 2011 2012 2013 2015 EURm gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 gnuplot_plot_4 BA IB VY IAG
IAG Capital Expenditure
IAG Capital Expenditure Produced by GNUPLOT 4.6 patchlevel 1 0 500 1,000 1,500 2,000 2,500 2011 2012 2013 2014 2015 gnuplot_plot_1 gnuplot_plot_2 gnuplot_plot_3 Y2011 Y2012 Y2013
Gnuplot Produced by GNUPLOT 4.6 patchlevel 1 0 1 2 3 4 5 6 7 8 Ryanair vueling easyJet norwegian airberlin EURc / ASK gnuplot_plot_1

Download PDF