Return of the business traveller and cargo growth fuels financial results for BA, Iberia

BA surprises with GBP298m operating profit

British Airways confounded critics and doom-mongers alike by revealing it made a pre-tax profit of GBP298 million in the first half of fiscal year 2010/11(1H10), compared with a loss of GBP111 million in the previous corresponding period (pcp).

The result was even more surprising in the light of the outburst by Chairman Martin Broughton only a week earlier against airport security requirements, which was interpreted by some analysts in the UK as being an advance diversion from poor financial results.

Table 1: BA financial/traffic highlights, six months ended 30-Sep-2010 (all financial figures in GBP million)

Measure	Amount GBP million	Variation %
Revenue	4447	+8.4
Operating costs	4149	+1.5
(Fuel)	1257	-2.4
(Labour)	1003	+2.7
Operating profit	298	Cf (111) in pcp
Profit before tax	158	Cf (292) in pcp
Net profit	107	Cf (217) in pcp
Passenger numbers	16.5 million	-7.3
Passenger load factor	79.2%	-1.4ppt
Cargo volume	375,000 tonnes	-0.5%
Pax revenue per ASK	GBP5.5p	+15.1%
Pax yield	GBP7.02p	+17.2%
Cargo yield	GBP15.26p	+36.1%
Operating cash flow	GBP554	+544%
Cash and cash equivalents	GBP550 million	+31.3%

BA referred to "permanent structural change across the airline" in its accompanying statement. Clearly the airline is a work in progress as it seeks to recover from two bad years during which it went from recording its best ever profit to its worst ever loss; subsequently made worse by Apr-2010's volcanic ash cloud, which shut it down for six days, and two bouts of cabin crew strike action, which saw it even wet-leasing aircraft from arch rival Ryanair. Indeed, those cumulative negative factors brought about some eyebrow-raising when the results were announced.

What BA has done successfully during the past two years is reduce its manpower cost base considerably - though there is some way to go as evidenced by the 2.7% increase in labour costs in 1H2010. With fuel costs stable (and reduced in BA's case, where Air France's and Lufthansa's have increased), the airline is in a position to benefit from improving yields, rather than from more passengers (actually -7.3%). Those yields were up by 17.2%, and revenue per ASK by 15.1%, the yield increase outstripping the decline in passenger numbers (by 8.7%), as more business passengers travelled (mainly long haul) to seek contracts on continents where the economic upturn is much more in evidence than in the UK. Another plus is a big increase in air cargo yield in the period (+36.1%), while tonnage again fell, by 0.5%. BA now has a much improved cash position of over GBP500 million.

BA will be glad to see its new partner in the International Airlines Group, Iberia, also recording a pre-tax profit (in the quarter ending 30-Sep-2010) of EUR53 million, having lost EUR182 million in the pcp. Iberia recorded an improved load factor (85.6%) and a 4.3% growth in average earnings per RPK, again mainly as a result of the increase in the number of long-haul business-class passengers and a BA-style application of cost control measures. Cargo was also a star performer for Iberia, with an increase of 32.4%.

APD increase a threat

The big test for BA now, apart from another slide in the global economy, which is anticipated, will be the effect of the Airline Passenger Duty (APD) increases, which took effect from 01-Nov and which make the UK the most heavily taxed country on the planet in respect of aviation.

Air France demonstrated similar resilience in the quarter ending 30-Sep-2010 without being able to turn its own large operating loss in the pcp into a profit. It did, though, manage to reduce that loss by 73% to EUR132 million. Again, yield (+11.8%) and revenue per ASK (+14.8%) increased, though not by quite the same degree as at BA. Air France's cargo business performed very well with a 40% increase in yield and 54% increase in cargo revenue per ATK.

These much improved cargo results for BA and Air France lend weight to Boeing's theory, widely publicised this week, that cargo volume will increase by almost 6% per annum over two decades, and triple by 2030.

Table 2: Air France consolidated financial/traffic highlights, three months ended 30-Sep-2010 (all financial figures in EUR million)

Measure	Amount EUR million	Variation %
Revenue	5721	+10.7
Operating costs	5936	+3.9
(Fuel)	1441	+26.8
(Labour)	1867	-1.4
Operating profit (loss)	(132)	Cf (496) in pcp
Adjusted operating profit	26	Cf (496 in pcp)
Net profit	736	Cf (426) in pcp
Total assets	29,552	Cf 27,775 at 31-Mar-2010
Operating cash flow	570	n/a
Net debt	6060	Cf 6220 at 31-Mar-2010
Passenger traffic (RPKs)	n/a	-2.3%
Load factor	81.5%	+2.2 ppts
Passenger yield	EUR8.45	+11.8%
Passenger revenue per ASK	EUR6.89	+14.8%
Passenger cost per ASK	EUR7.04	+8.9%
Cargo traffic (FTKs)	n/a	+2.6%
Cargo yield	EUR26.09	+39.9%
Cargo revenue per ATK	EUR18.15	+54.1%
Cargo costs per ATK	EUR17.62	+9.8

As a result, Air France-KLM's CEO, Pierre-Henri Gourgeon, advised in an update of the group's activity to the Board in late Oct-2010 that the group has upwardly revised its operating result expectations for the 12 months ending 31-Mar-2011. It now expects operating results to be positive, except in the case of a major adverse event (glacial ice is melting under the Grímsvötn lakes in Iceland as this is written, potentially heralding another sub-glacial volcanic eruption), given the revenue performance of recent months, together with the level of forward bookings. The group had previously stated in Jul-2010 that it expected to break even at the operating level for the year, excluding the impact of air space closure in Apr-2010 (a loss estimated at EUR158 million). AF-KLM will increase capacity (ASMs) by 3.3% for its winter 2010/11 schedule, compared with the pcp. The carriers plan to expand long-haul capacity by 4.1%, while medium-haul capacity will increase by 0.5%.

Domestic LCC could be established

Air France is reportedly considering establishing a domestic LCC, due to intensified competition from foreign budget airlines in the French market. The new airline, reportedly to be named Air France Express, could be established in 2011 with bases in the southern cities of Marseille (where Ryanair is pulling out in a dispute over employee contracts), Nice and Toulouse if an agreement can be reached with unions. AF-KLM already operates a low-cost unit in Transavia, which is set to take over responsibility for more short-haul routes from KLM at Amsterdam Schiphol Airport.

Another major European airline that was already profitable at operating, net and EBIT levels and which continues to build on that position is Lufthansa.

A revenue increase in the quarter of 27.5% bore witness to a positive revenue performance in all segments apart from IT (-1.3%), an overall operating profit that rose by almost 260% for the group, EBIT by 148% and net profit by 200%.

However, operating profit in the MRO and catering segments fell sharply. Lufthansa's growth is being fired by increased passenger activity, again predominately on long-haul services; also by logistics and catering activities.

Table 3: Lufthansa consolidated financial/traffic highlights, three months ended 30-Sep-2010 (all financial figures in EUR million)

Measure	Amount EUR million	Variation %
Revenue	7568	+27.5
(LH passenger airline group)	5893	+28.7
(Logistics)	731	+54.5
(MRO)	1009	+8
(IT services)	147	-1.3
(Catering)	618	+10.0
Operating profit (loss)	783	+259.2
(LH passenger airline group)	560	+174.5
(Logistics)	86	Cf (66) loss in pcp
(MRO)	66	-22.4
(IT Services)	4	-20.0
(Catering)	37	+32.1
EBIT	893	+148.7
Net profit	628	+200.5
Operating cash flow	1005	+146.3

Results for the nine months ending 30-Sep-2010, which are more comprehensive and include a breakdown for subsidiary airlines, are broadly similar, though it is clear that most of the improvement came in the past three months.

Table 4: Lufthansa consolidated financial/traffic highlights, nine months ended 30-Sep-2010 (all financial figures in EUR million)

Measure	Amount EUR million	Variation %
Revenue	20,193	+24.9
(LH passenger airline group)	15,460	+28.3
(Lufthansa passenger airlines)	10,248	+12.6
(Swiss)	2556	+23.7
(Austrian Airlines)	1538	n/a
(bmi - British Midland International)	696	n/a
(Germanwings)	486	+7.8
Operating costs	21,476	+20.6
(Labour)	4820	+11.9
(Fuel)	3859	+47.7
Operating profit	612	+170.8
(LH passenger airline group)	218	-8.8
(Lufthansa passenger airlines)	18	+338.9
(SWISS)	194	+158.7
(Austrian Airlines)	47	n/a
(bmi - British Midland International)	(90)	n/a
(Germanwings)	(11)	Cf. 39 in pcp
Net profit	524	Cf. 31 in pcp
Operating cash flow	2425	+68.6
Total assets	29,501	+8.1
Net indebtedness	1521	-20.3
Passenger numbers	67.9 million	+22
(Austrian Airlines)	8.2 million	+11.3
(Germanwings)	6.0 million	+8.9
Passenger load factor	79.7	+1.7 ppts
(SWISS)	82.3	+3.1 ppts
(Austrian Airlines)	77.2	+3.3 ppts
(Germanwings)	77.8	(-3 ppts)
Cargo volume	1.5 million tonnes	+19.3

Like Air France, Lufthansa's Executive Board also revised its expectations for earnings upwards and now anticipates that the operating result for the full year will exceed the EUR800 million mark. Capacity will be increased by 6-10% in 2011, with the phasing in of A380s on long-haul routes, new A330s for SWISS and the phasing out of smaller aircraft on regional routes.

SWISS operating profit up by 158%

The notable facts emerging from table 4 are that (1) the group has incurred fuel costs 47.7% greater than in the pcp, twice the rise in revenues. The carrier now forecasts 2011 fuel costs of EUR6 billion, based on a crude oil outlook of approximately USD87 per barrel. Lufthansa previously forecast fuel costs for 2010 of EUR5.2 billion, up from EUR3.7 billion in 2009. (2) That SWISS is the star performer of the subsidiary companies. SWISS is now re-established as a mature company and it shows in a revenue increase of 23.7% and an operating profit gain of 158.7% in the nine-month period. Both the LCC Germanwings and the unwanted and unloved British Midland International recorded operating losses and even though bmi operates extensively from the same London Heathrow base where BA has done so well.

Lufthansa is pressing ahead with its acquisition of 40 Airbus aircraft and eight Embraer regional jets. The orders are valued at approximately EUR3.5 billion at list prices. The orders comprise: 20 x A320 family aircraft and three A330-300s for Lufthansa; eight E195s for Lufthansa Regional; two A320s, two A321s and five A330-300s for SWISS and eight A319s for Germanwings. The group's Airbus order backlog has increased to 91 aircraft.

Fellow Star Alliance member LOT Polish Airlines is the most likely target for the Lufthansa Group's next acquisition. The airlines held talks in May-2009 when LOT was suffering as a result of the financial crisis; however, its performance has since improved markedly, increasing passenger numbers by 9% between Jan-Aug-2010 and reducing losses.

Middle Eastern airlines are a common concern

Common to all three airlines is concern about the growing influence of Middle Eastern carriers. Air France CEO Gourgeon joined BA and Lufthansa in calling on the European Union to curb the expansion of Gulf carriers, stating the region's status as an air-travel hub is under threat. The carriers' are also joining American Airlines in pushing for a change to the export-guarantee aircraft financing regime and the trans-Atlantic trade agreement which is behind the decision, with the carriers arguing that it enables cheaper government-backed aircraft financing available to rivals from countries including Gulf states. The carriers added that they are at a disadvantage to their Middle East competitors which they claim receive low airport charges and fuel taxes at their respective home airports.