21-Feb-2014 8:37 PM

Air France-KLM back in operating profit. GOL purchase expands its partner options beyond SkyTeam

Analysis

Air France-KLM's 2013 results saw its operating result return to profit for only the second time in six years, but the operating margin of just 0.5% (and another net loss) highlights that its Transform restructuring programme still has work to do. A return to profit in the passenger business was instrumental in the improved group result, while the cargo segment remained in loss and the maintenance division continued to produce healthy results.

2014 will see a modest increase in ASKs of around 1% overall, down 2% on medium-haul and up 2% on long-haul. The strongest area of growth will be Latin America and the group's position in that market should be enhanced by a newly announced partnership with GOL (including the acquisition by Air France-KLM for USD52 million of a 1.5% equity stake in the Brazilian carrier) that broadly mirrors SkyTeam partner Delta's relationship with GOL.

The North Atlantic JV within SkyTeam delivers significant unit revenue benefits, but the deal with GOL expands Air France-KLM's options. This, and its indication that it is seeking to deepen its relationship with Etihad, are further signs that SkyTeam cannot satisfy all its needs.

Summary

Air France-KLM's operating result returned to profit in 2013, but the operating margin was only 0.5%, indicating that the Transform restructuring program still needs work.
The passenger business was the main driver of the improved group result, while the cargo segment remained in loss and the maintenance division performed well.
Air France-KLM plans a modest increase in ASKs of around 1% in 2014, with the strongest growth expected in Latin America.
The partnership with GOL in Brazil and the potential deepening of the relationship with Etihad indicate that SkyTeam cannot meet all of Air France-KLM's needs.
The net loss for Air France-KLM widened in 2013, but this was partly due to non-cash accounting items and restructuring costs.
The group aims to reduce unit costs further in 2014 and is targeting an increase in EBITDA to around EUR2.5 billion, subject to no reversal in current operating trends.

Return to operating profit, but net loss widens

Air France-KLM widened its reported net loss by almost a half from EUR1.2 billion in 2012 to EUR1.8 billion in 2013. However, the picture is complicated by non-cash accounting items adversely affecting this result, in particular a EUR937 million impairment of deferred tax assets, restructuring costs and a EUR119 million write down in the value of its shares in Alitalia. Air France-KLM says that its net loss adjusted for such items narrowed from EUR696 million to EUR349 million. Reported revenues grew by just 0.4% to EUR25.5 billion.

Perhaps a better picture of the group's underlying profitability comes from the progress of the operating result, which returned to positive territory with a profit of EUR130 million, compared with a EUR336 million loss in 2012 (restated for changes in accounting standards).

Air France-KLM financial highlights: 2013

EUR million except where stated	2012*	2013	*Change*
Revenue	25,423	25,520	0.4%
EBITDAR	2,351	2,768	17.7%
EBITDA	1,394	1,855	33.1%
Operating result	-336	130	+446
Net profit	-1,225	-1,827	-602
Net debt	5,966	5,348	-618
Equity	3,637	2,290	-1,347
Net debt to equity	164%	234%	+70ppts

Nevertheless, even the reported operating result does not give a totally unrestricted view of Air France-KLM's performance. The disposal of its regional subsidiary CityJet to Intro Aviation is in progress and accounting standards require its results to be reclassified as discontinued operations are excluded from the headline group results. CityJet's operating loss widened from EUR17 million in 2012 to EUR19 million in 2013.

If this loss is subtracted from the group's reported operating profit, the resulting figure of EUR111 million was a little below the EUR125 million implied by Air France-KLM's guidance that its 2H2013 operating result would show the same year on year improvement as recorded in 1H2013, although adverse currency movements were more significant in 2H.

Both the reported operating result and the figure adjusted to include the CityJet result were a little lower than the consensus forecast of EUR152 million (the median forecast of 20 analysts following Air France-KLM (source: Air France-KLM investor relations web page)).

Air France-KLM net profit and operating profit (12 month period to date shown, EUR million): 2005-2013

The passenger segment remains key to group result

By segment, the passenger business remains the key to group profits and this division returned to a small operating profit of EUR174 million in 2013 (loss of EUR260 million in 2012). Its profit margin of 0.9% remains well short of the levels achieved in the early years after the merger of Air France and KLM in 2004 and before the global financial crisis. Restructuring measures appear to be starting to have a positive impact on this division.

The cargo segment, also an area of restructuring focus, remains in loss (to the extent of EUR61 million) although its operating result improved by EUR82 million in 2013. The maintenance division has been the group's best performer, recording an operating profit every year since the merger and achieving an operating margin of 13.0% in 2013.

Within the other segment, which made an operating profit of EUR1 million in 2013, a EUR24 million profit in caterer Servair was offset by a EUR23 million loss in leisure LCC Transavia. Transavia France was close to breakeven, while Transavia Netherlands was loss-making, partly as a result of difficulties felt by Dutch tour operators. Transavia was hit by political unrest in some Mediterranean destinations and by launch costs on a number of routes. Mr de Juniac said that he expected Transavia to be profitable in 2016.

Air France-KLM operating profit by business segment (12 month period to date shown, EUR million): 2005-2012

Net debt is reduced, but the gearing increases

A key goal for the group in 2013 was to reduce its net debt and it managed to lower the level by EUR618 million to end the year with a figure of EUR5.3 billion. This was mainly the result of improved operating cash flow. The group's gross cash balance stood at EUR4.2 billion at the end of 2013, compared with EUR3.9 billion a year earlier, and it also has undrawn credit lines of EUR1.8 billion.

The gross cash balance is equivalent to 60 days of sales, a reasonable cushion and the inclusion of the available credit gives the group a strong liquidity position, even if financial gearing (the ratio of net debt to equity) increased.

CFO Pierre Francois Riolacci told analysts at the results presentation that recent rumours of a planned capital increase were unfounded. "A rights issue is not required and not justified", he said.

Air France-KLM development of net debt and cash: 2005-2012

Load factor is at record levels, but RASK was weakened by currency movements

The Air France-KLM Group increased passenger capacity (ASK) by 1.5% in 2013 and saw another increase in load factor, this time by 0.6ppts, to an impressive 83.7%. Revenue per ASK (RASK) in the passenger business fell by 1.0% year on year, but this was adversely affected by changes in foreign exchange rates. Ex currency RASK grew by 0.8%, mainly reflecting the improved load factor.

Ex currency RASK was up 0.6% on long-haul (down 0.6% on long-haul premium and up 1.2% on long-haul economy) and up 2.4% on medium-haul.

Air France-KLM development of capacity (ASK million) and load factor (%) (12 month period to date shown): 2007-2012.

Capacity growth was focused on the long-haul network, with ASKs up 2.4%, while medium-haul capacity was down 1.2%. Medium-haul point to point capacity was down by 8.3%, reflecting the restructuring of Air France's activities in this area. On the long-haul network, ASK growth was highest in Latin America (+7.4%) and Asia (+4.3%). There was a capacity reduction of 1.2% on the mainly leisure oriented Caribbean and Indian Ocean.

The development of ex currency RASK was strongest on the medium-haul hub network (+3.2%) and in Latin America (+2.9%), in spite of the rapid capacity increase there. North America also saw healthy ex currency RASK development, up 2.0%. Competitive pressures in Asia and Africa/Middle East led to falling ex currency RASK.

Air France-KLM development of capacity (ASK), traffic (RPK) and unit revenue (RASK, ex currency) by region: 2013

Revenues were just above flat on 2012 levels

Revenue growth of 0.4% mainly reflected the modest development of passenger revenues, with growth in maintenance revenues offset by falling cargo revenues. The cargo division saw a capacity cut of 2.7%, with full freighter capacity down 11.5% (greater than the 6% cut planned at the start of 2013). In spite of the cargo capacity cut, cargo load factor and unit revenues continued to fall.

Air France-KLM revenues (EUR million): 2012 and 2013

	2012	2013	Change	% of 2013 revenue
Passenger	19,976	20,112	0.7%	79%
Cargo	3,057	2,816	-7.9%	11%
Maintenance	1,096	1,225	11.8%	5%
Other	1,294	1,367	5.6%	5%
Total	25,423	25,520	0.4%	100%

Air France-KLM revenues by segment (12 month period to date shown, EUR million): 2005-2012

Geographical breakdown of traffic revenues by region of destination (12 month period to date shown, EUR million): 2006-2012

Costs down 1.5%, helped by a drop in fuel costs

Total operating costs were down by 1.5% in 2013, below the growth in revenues and lower than capacity growth. This performance was helped by a 5.2% fall in fuel costs, the second largest cost category (27% of total costs). Costs excluding fuel were held flat, while employee costs (the largest cost, accounting for 29% of the total) fell by 2.3% on a 4.3% reduction in headcount.

Air France-KLM operating costs EUR million: 2012 and 2013

	2012	2013	Change	% of 2012 costs
Aircraft fuel	7278	6,897	-5.2%	27%
Chartering costs	551	455	-17.4%	2%
Aircraft operating lease costs	949	913	-3.8%	4%
Landing fees and en route charges	1832	1,839	0.4%	7%
Catering	591	589	-0.3%	2%
Handling charges and other operating costs	1368	1,405	2.7%	6%
Aircraft maintenance costs	1131	1,303	15.2%	5%
Commercial and distribution costs	866	852	-1.6%	3%
Salaries and related costs	7662	7,482	-2.3%	29%
Amortization and depreciation	1576	1,566	-0.6%	6%
All other	1971	2,099	6.5%	8%
Total	25,775	25,400	-1.5%	100%
Costs ex fuel	18,497	18,503	0.0%	73%

Labour productivity improvements

Air France-KLM employee cost and headcount reduction

Reduction in headcount and employee costs are a key element of the Transform restructuring programme. In addition, agreements have been reached with employee groups over productivity improvements.

Air France-KLM improved labour efficiency indicators

This is starting to have an impact on the group's labour productivity indicators, as calculated by CAPA. Although average cost per employee increased by 2.1%, a greater increase in ATK per employee meant that employee cost per ATK fell by 2.1%. Moreover, revenue per employee grew by 4.0%.

Air France-KLM labour productivity measures: 2011, 2012 and 2013

	2011*	2012	2013	Change
Total full time equivalent headcount	102,012	100,744	96,417	-4.3%
Total labour cost EUR mill	7,460	7,660	7,482	-2.3%
Employee cost per employee (EUR)	73,129	76,034	77,600	2.1%
ATK per employee	429	430	448	4.2%
Employee costs per ATK (EUR)	17.0	17.7	17.3	-2.1%
Revenue per employee	238,825	254,437	264,684	4.0%

Further unit cost reduction targeted

Putting Air France-KLM's 2013 unit cost performance into a slightly longer term context, it has maintained a decent level of control over ex fuel unit costs since 2005, although ex fuel CASK increased slightly in 2012 before dropping again in 2013. Compared with the heavy loss-making year to Mar-2010, ex fuel CASK was down 3% in 2013.

Unfortunately, fuel costs also have to be met and total CASK has increased by 8% since then. Profitability has improved since Mar-2010 mainly because RASK growth has outpaced CASK growth, but profits remain very slender. Although product improvements, such as new long-haul business class seats, may have a stabilising effect on RASK, it is a notoriously fickle friend and Air France-KLM is right to target further unit cost reduction. In 2014, it is seeking a 2% fall in unit costs ex fuel and at constant exchange rates.

Air France-KLM - index of operating cost per ASK and fare revenues per ASK (each indexed to 100 in year to March 2010)

2014 ASK growth focuses on long-haul

The group plans ASK growth in 2014 of only around 1%. On medium-haul, capacity will be down by 2% overall, masking a severe cut in point to point capacity (-16%, of which 5% from the sale of CityJet) and a 3% increase in medium-haul capacity from the hubs of Paris CDG and Amsterdam. The medium-haul capacity plan follows that outlined when the group announced its additional measures to improve profitability in this area in Oct-2013 and Nov-2013.

See related reports:

Capacity growth will mainly focus on the long-haul network (ASK +2% in 2014), where Air France-KLM highlighted its strong market position on routes from Europe to each of the major world regions.

Air France-KLM planned growth in capacity (ASK): 2014

A new agreement with GOL should help Latin American growth

Air France-KLM's position in Latin America should be further strengthened by the enhanced partnership with GOL, building on codeshare arrangements in place since 2009. Brazil, with the World Cup imminent and the Olympics to follow in 2016 was a big hole in its network

As part of the new agreement announced on 20-Feb-2014, Air France-KLM will invest USD100 million, including a USD52 million for a 1.5% equity stake in GOL, with whom it has agreed an extended codeshare agreement and exclusive commercial cooperation between Europe and Brazil.

The partnership also includes increased network coordination, the coordination of sales teams and a maintenance agreement. Air France-KLM's North Atlantic partner and fellow SkyTeam member Delta already has a close relationship with GOL, including codeshares and a 6% equity stake.

Air France-KLM plans to grow fastest on its Latin America network in 2014, with ASKs planned to increase by 9%.

The group will add 28%capacity to Brazil in summer 2014 versus summer 2013, with the addition of Brasilia. Elsewhere in Latin America, it will add Montevideo as a new destination, grow capacity to Buenos Aires and Lima by 40% and double its capacity to Panama and Santiago.

It expects to be the number one carrier between Europe and Latin America in summer 2014, with 12 destinations (of which six served from both Paris and Amsterdam).

Air France-KLM long haul network market position by region summer: 2013

North Atlantic JV is delivering strong RASK benefits

On the North Atlantic, Air France-KLM says that it has seen the best improvement in RASK since 2008 among European competitors, with an improvement in profit margin of 11 ppts over this period. The anti-trust immunised joint venture with Delta and Alitalia accounts for 23% of industry capacity on the North Atlantic and USD11 billion in revenues.

Given Air France-KLM's weak profitability in recent years, this JV has certainly helped to keep it afloat.

North Atlantic RASK: 2013 vs 2008

Towards a deeper partnership with Etihad also - and Jet Airways? Alitalia could help bind the family

Air France-KLM also highlighted "ongoing discussions" to deepen its partnership with Etihad, although Mr de Juniac ruled out granting its Abu Dhabi-based codeshare partner access to the Flying Blue FFP. He also ruled out the idea that Etihad might one day invest in Air France-KLM. His presentation made reference to the complementary nature of the two groups geographically and the addition of destinations in the Indian Ocean and Australia. In addition, an extension of Air France-KLM's codeshare relationship with Jet Airways (an Etihad equity investment) is being considered.

Given Air France-KLM's relationship with Etihad and its "strong partnership" with Alitalia, Mr de Juniac said that he "cannot imagine" that Etihad's consideration of taking a stake in the Italian carrier would be "unfriendly" towards Air France-KLM as this would "destroy value in Alitalia".

Certainly, Air France-KLM is increasingly looking pragmatically outside SkyTeam to seek value in regions where it sees growth opportunities.

Using the Etihad equity alliance, without formally becoming part of it, seems to offer increasing value in a fast changing partnership environment. By playing outside its core alliance, Air France-KLM is hoping to achieve the best of all worlds.

There can be no further slippage in financial targets

Air France-KLM is still targeting EBITDA of around EUR2.5 billion in 2014 "subject to there being no reversal in current operating trends". This would represent an improvement of around EUR600 to EUR650 million from 2013's result, compared with an improvement of EUR461 million in 2013 versus 2012. Given increasing momentum with the Transform restructuring programme and some economic stability, this looks achievable.

However, its Transform target had originally targeted EUR2.5 billion to EUR3.0 billion of EBITDA in 2014. Moreover, its EUR4.5 billion net debt target for Dec-2015 had originally been set for Dec-2014.

At least the group's targets are not slipping further and it is now starting to talk about things other than restructuring, such as planned long-haul product upgrades for both Air France and KLM and the expansion of the Latin America network.

Restructuring, specifically cost reduction, remains the number one priority. But clearly the attraction of pragmatic partnership making is becoming more and more a preoccupation with the SkyTeam leader.