IAG first quarter operating loss doubles on shabby Iberia performance and pilot strikes

"Iberia's performance reflects the weakness of the Spanish domestic market and industrial action by pilots opposed to actions by Iberia's management to improve the airline's efficiencies. For British Airways, although the London market and demand for transatlantic travel remains strong, its performance has been affected by rising fuel costs," IAG Willie Walsh said.

Financial highlights for Europe's three largest airline groups: 1Q2012

Source: Lufthansa Group, Air France-KLM Group & IAG

Mr Walsh also took a swing at the UK and Spanish Government for imposing higher taxes. "The financial performance of our business continues to be undermined by government actions. In addition to the UK government increasing the world's highest aviation tax - Air Passenger Duty - by double the inflation rate, the Spanish government plans to increase departure taxes from Spain by up to EUR10 per passenger," Mr Walsh said.

In a conference call with analyst presenting the 1Q2012 results, Mr Walsh warned that if the Spanish Government confirms the higher charges at Madrid this will have an impact on IAG's capacity plans at the airport. "The Spanish government has indicated it is likely to increase charges at Madrid airport. This will have an impact on capacity planning, not just within the IAG group but at other airlines also," Mr Walsh said, adding it would be very "foolish" for the Government to endorse the planned charge increases, which would lead to a traffic reduction. "We will push to have these charge increases set aside," Mr Walsh vowed.

While right in opposing the proposed airport charges increase at Madrid, Mr Walsh's threat to reduce capacity growth at Madrid is rather surprising since the Iberia hub has plenty of runway capacity in contrast to the congested BA hub at London Heathrow. In past presentations, IAG has always pointed to the growth potential of Madrid as compared to Heathrow.

Fuel burden outweighs revenue growth at IAG

Operating expenses before exceptional items increased 11.5% to EUR4.2 billion, with fuel costs being 7.5% of this increase. The Group's fuel costs in 1Q2012 rose 24.9% year-on-year, driven by higher prices, the reduced impact of hedging and emissions charges.

Emissions trading charges of EUR15 million were incurred for the first time and are included within fuel costs. Virtually all airlines operating to/ from an airport in the EU and the EEA (Norway, Iceland and Lichtenstein) are included in the European Union's carbon-dioxide Emissions Trading Scheme (EU ETS) as of Jan-2012.

IAG fuel costs: 1Q2011 vs 1Q2012

Source: IAG

At the current oil price and EUR/USD exchange rates, IAG expects fuel-cost increase for the full year of over EUR1 billion, though the year-over-year impact should be less severe in the second half.

In what is typically a weak quarter for European airlines, IAG grew total revenue 7.8% and passenger revenue 9% to EUR 3.3 billion on a 1.2% decrease in passenger numbers to 11.4 million. System wide capacity was virtually flat on the year-ago period (+0.6%).

IAG had planned for a limited 2.2% increase in ASKs in the first three months, but this could not take place due to the industrial action by the Iberia pilots. Seat factor rose 2.2 ppts to 76.1% and yields increased 5.3% while RASK rose 8.5%. IAG's improvement in yield and RASK compares favorably to Air France-KLM Group, which grew yield 1.9% and passenger unit revenue per ASK by 5.6% in 1Q2012.

IAG CFO Enrique Dupuy noted during the results presentation with analysts that 1Q2012 passenger unit revenue level of EUR 6.53 cents is "significantly higher than the previous high water mark of 1Q2009" of EUR 6.37 cents, but he pointed out that "significant unit revenue momentum is still required to overcome fuel headwind through 1H2012". RASK has gone up at IAG on a pro forma basis for nine consecutive quarters.

The Group realised a growth in passenger unit revenue across its network, with a continued growth on North American routes, "particularly in premium cabins," Mr Dupuy said. The improvement in RASK on Asia Pacific routes was driven by China and Japan and the consolidation on routes falling under the scope of the BA/Qantas joint service agreement.

IAG % change in passenger revenues per ASK by region: 1Q2012 vs 1Q2011

Source: IAG

IAG has achieved load factor improvements on a balanced capacity approach and it has indicated it will maintain this throughout the year. Overall 2012 planned capacity growth is just 2% comprising a 2.3% increase in 1Q2012, 1.7% in 3Q2012 and 1.6% increase in 4Q2012. This excludes bmi, which it acquired in Apr-2012 and is starting to fully integrate.

IAG formally completed the purchase of bmi from Lufthansa on 20-Apr-2012. IAG has started to integrate bmi mainline into British Airways' London Heathrow operations and the 90 day-consultation with bmi staff and trade unions has already commenced. Up to 1200 of the 2700 employees at bmi mainline may be made redundant, with many job losses to come from the closure of bmi's headquarters at Castle Donington, IAG reiterated during the 1Q2012 results presentation. As bmi units bmibaby and bmi Regional are of no interest to BA, IAG has announced the gradual grounding of the LCC subsidiary and on 10-May-2012 signed a binding agreement on the sale of bmi Regional.

See related articles:

• UK carriers rush to snap up bmibaby's planned route closures

• British Airways plans two phases to bring bmi, and its London Heathrow slots, to profitability

IAG to start transitioning bmi routes to BA later this month

On 23-May-2012 the first nine bmi routes from Heathrow to Bergen, Basel, Nice, Vienna, Stavangar, Hanover, Agadir, Marrakech and Casablanca will move over to BA flight codes. The second tranche of flights will follow in Jun-2012. The bmi flights will fall under oneworld as they move to BA flight numbers. bmi was a Star Alliance member.

The transition of the bmi Air Operator's Certificate (AOC) to BA's AOC is planned to start at the end of May-2012 and will proceed aircraft (with crews) by aircraft. The BA livery will be installed as each aircraft is transferred to the BA AOC and the first bmi Airbus A320 family aircraft is currently in the paint shop. The aircraft AOC transfer should be complete by the end of 2012, Mr Walsh said.

Mr Walsh stated that the customer base of bmi had deteriorated quite rapidly from last year onwards owing to the uncertainty of its ownership, adding to the unprofitability of the carrier. "Seat factor is around 50% ... that is appalling for Heathrow."

bmi Group has reported an operating loss for 2011 of EUR200 million, of which 80% relates to bmi mainline. BA CEO Keith Williams said bmi will report further losses in 2012 with an anticipated post-acquisition share (Apr-2012 to Dec-2012) operating loss of approximately EUR150 million. In addition, IAG will book EUR90 million of the expected EUR115 million restructuring cost to be booked in 2012.

Mr Williams cited the Chinese proverb "Even when opportunity knocks, a man still has to get up off his seat and open the door" to reassure analysts that the bmi acquisition is the right investment as it comes with an additional 56 slot pairs at Heathrow, lifting the company's slot portfolio at the congested airport to over 50%. IAG also expects about EUR100 million annually in improvements from bmi at the operating level by 2015.

IAG outlook for bmi: 2015

Source: IAG

IAG aims to begin the schedule optimisation of BA and bmi from the winter season 2012/13 and the bmi acquisition has already resulted in one new long-haul route, to Seoul. The Seoul route was made possible as a bmi A320 will take over a BA route currently operated with a Boeing 767 and this aircraft in turn will be used on a route presently operated with a 777, freeing up the 777 for Seoul.

See related article: BA resumes Seoul service with more Asian destinations to come as BA integrates bmi

The winter schedule will be announced in June and the network optimisation should take place over the London airports where BA operates: Heathrow, London City and Gatwick. Mr Walsh indicated that Gatwick offers growth opportunities for BA, particularly on long-haul. "The new owners brought a more ambitious focus," Mr Walsh said.

The statement is intriguing as BA in 2000 restructured its operations on the basis that it could not profitably operate two hubs in the same city. BA then was the largest operator at Gatwick; now it is easyJet.

With the bmi acquisition enlarging its slot portfolio at Heathrow and 787s and A380s coming into the BA fleet, there seems to be little need to expand long-haul at a second London airport, at least not for the time being unless it hopes to tap into a less business oriented market and increase pressure on easyJet and Ryanair with a more diverse network of medium-haul and long-haul. BA has been very proactive recently in promoting the attractiveness of its all-in fares to the public trying to regain part of its market share it lost to LCCs.

BA will not convert all of its new newly acquired bmi slots in long-haul slots, because long-haul needs feed from short-haul even in a strong O&D market like the London. IAG believes that one third of bmi's short-haul slots could transfer into long-haul use "because this reflects the mix between short-haul and long-haul we now have and we believe this to be the right mix. More long-haul requires more feed from short-haul," Mr Walsh said. In the short- and medium-term, BA will also face the challenge of securing available long-haul aircraft, as evidenced by the circuitous (yet effective) availing of a 777 via A320 and 767 switches.

bmi Regional sold to Sector Aviation Holdings

On 10-May-2012 IAG signed a binding agreement to sell bmi Regional to Sector Aviation Holdings Ltd (SAH) for a total consideration of GBP8 million in cash. The sale includes all bmi Regional's fixed assets and long-term liabilities, including owned and operating lease aircraft.

Aberdeen-based bmi Regional operates a fleet of 18 Embraer regional jets on scheduled services throughout the UK and Northern Europe. As a Star Alliance partner, bmi Regional connects UK regional airports with other Star airlines hubs, such as Glasgow-Copenhagen, East Midlands-Frankfurt, Edinburgh-Zurich and Leeds/Bratford-Brussels. bmi mainline also used bmi Regional aircraft on a selected number of routes to Heathrow, such as Heathrow to/from Aberdeen, Manchester and Hannover but those are bmi mainline routes using bmi slots at Heathrow.

bmi Regional fleet summary as at 11-May-2012

Source: CAPA - Centre for Aviation

The sale is conditional upon approval of the UK Civil Aviation Authority and it is anticipated that ownership will be transferred to SAH before the end of May-2012. "This deal provides a future for bmi Regional and should secure around 330 jobs," Mr Walsh says.

Sector Aviation is being funded by Stephen and Peter Bond, who are also investors in the Scottish regional carrier Loganair. Loganair in Jul-2008 signed a franchise agreement with Flybe replacing a similar and 14 year-long cooperation with BA. BA has a 15% shareholding in Flybe.

Weakness in Spain undermines strength out of London

In its first year as combined entity of BA and Iberia, IAG recorded a solid EUR407 million profit on operations, but the outlook for 2012 is less bright and Europe's third largest airline group expects its operating result to be "around the breakeven level" for the full year, after exceptional items. These include the non-recurring bmi restructuring cost. The cost of the bmi acquisition and integration is higher than that of the restructuring as such, and will dilute IAG's operating profit for the full year by EUR240 million.

The bmi acquisition was a rare opportunity which had to be seized and came at a low purchase price. Even European regulators were easy. But bmi is not IAG's problem. BA will absorb the relatively small carrier in a short timeframe; its slots will have a long-term return.

A larger problem facing IAG this year is fuel and the contrasting fortunes of its two operating entities. BA is benefiting from persistently strong demand in London, particularly for business-class and first-class seats on North Atlantic routes while Iberia is suffering from the struggling Spanish economy and weak euro zone macro-economic environment. Iberia is equally struggling to shake legacy off, bring operating efficiency up and costs down, with pilots opposing the creation of Iberia Express.

See related article: Iberia Express launches as Europe's latest salvo to bring short-haul model to profitability

There are hopeful signs a binding agreement is in the making and will be signed in a couple of weeks, but as IAG noted, the speed of revenue recovery post-strikes and the performance of the Spanish markets are unclear at this stage.

Background information

IAG financial highlights: 1Q2012 vs 1Q2011

Source: IAG