A promise that shareholders will benefit from the merger of airline operators British Airways and Iberia is looking hollow. Investors have lost half their wealth since shares in International Consolidated Airlines (IAG) began trading in January and, with more recession looming, there could be worse to come.
- Merger benefits to come
- BMI's Heathrow slots
- Massive fuel bill
- Weak economic outlook
- Doubts about ambitious targets
- Set to be hit by higher taxes
To be fair, management is only 10 months into the job and there is clear progress on efficiency. Still, chief executive Willie Walsh acknowledges that offsetting the airline's mammoth fuel bill while demand from travellers weakens will be the "main challenge for 2012". Indeed it will. Fuel makes up a third of all outgoings and IAG has spent over €3.7bn (£3.2bn) already this year flying its jets around the globe. Its annual tab will likely top €5bn.
And don't expect costs to fall in 2012. Fuel costs will be up around 14 per cent, or €700m, in 2012 and non-fuel costs will be flat, according to company estimates. Gerald Khoo, an analyst at broker Espirito Santo, reckons IAG would have to increase passenger revenue by 5 per cent just to offset higher fuel prices, but he forecasts only half that pace in 2012.
A seemingly-inevitable economic downturn in 2012 will add to IAG's woes. The impact on passenger volumes is already evident. Growth in lucrative premium traffic slowed to 1.9 per cent in October from high single digits over the summer, and non-premium business was similarly anaemic. Further downward pressure on passenger numbers in first and business class looks certain.
Planned increases in UK Air Passenger Duty, already the highest in the world, and entry into the Emissions Trading Scheme to cut carbon emissions don't come cheap either - the latter alone is expected to cost IAG €90m a year. Mr Walsh says the combination of both taxes is "unsustainable".
INTERNATIONAL CONSOLIDATED AIRLINES (IAG) | ||||
|---|---|---|---|---|
| ORD PRICE: | 143p | MARKET VALUE: | £2.65bn | |
| TOUCH: | 143-144p | 12-MONTH HIGH/LOW: | 307p | 130p |
| DIVIDEND YIELD: | nil | PE RATIO: | 19 | |
| NET ASSET VALUE: | 231p | NET DEBT: | 9% | |
| Year to 31 Dec | Turnover (€bn) | Pre-tax profit (€bn) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2009 | 13.5 | -1.16 | -42.0 | nil |
| 2010 | 14.8 | 0.08 | 5.4 | nil |
| 2011* | 16.3 | 0.32 | 13.1 | nil |
| 2012* | 16.7 | 0.22 | 8.8 | nil |
| % change | +3 | -33 | -33 | – |
Normal market size: 20,000 Matched Bargain Trading Beta: 1.5 *Espirito Santo forecasts £1 = €1.162 | ||||
What's more, third-quarter results were disappointing. Earnings downgrades followed after operating profit of €363m missed City estimates and the carrier guided towards profits of €450m for the full year.
Still, management remains bullish. At a presentation day for the City last month, it predicted IAG would make an operating profit of €1.5bn in 2015.
That raised an eyebrow or two. "These targets assume something rarely, if ever, achieved by an airline - retaining merger synergies and cost savings for shareholders," says Andrew Fitchie, an analyst at broker Investec Securities. "History is littered with examples of airline restructuring gains being competed away. We are not convinced these targets will be even remotely achieved."
To do it, the airline will have to increase merger savings from €400m to €450m a year, find structural improvements of €400m and expand capacity to drive organic growth of €150m. Yes, IAG's delivery plan is detailed and plausible, but "such programs are not without risk and are often overtaken by general cost inflation," points out Mr Fitchie.
New fuel-efficient planes could eventually save €250m a year, but the €4.6bn that IAG will spend on the aircraft, two-thirds of €7.7bn capital spending planned for 2012-15, is truly eye-watering.
Hasty acquisitions may prove risky, too. If IAG does buy Lufthansa's BMI business - expected to cost around £300m and lose €250m this year - there is a real chance that the anti-trust authorities will only let the airline hang on to a few of BMI's valuable landing slots at Heathrow. And, given that BMI is struggling, earnings downgrades will surely follow.
