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Iberia: capacity stabilises. IAG focuses growth on Level, its new long haul LCC

Iberia's 'Plan de Futuro' restructuring restored its profitability in 2014 and it achieved its third straight positive operating result in 2016. Its owner, IAG, rewarded it with a return to capacity growth after years of cuts and new aircraft orders. Iberia's improved returns, and a drop in performance by sister airline Vueling, lifted it from the bottom of the IAG pack in 2016.

Nevertheless, Iberia is still not earning its cost of capital and is some way short of IAG's even higher target return. Iberia's capacity growth is slowing, as it concentrates more on load factor gains in a market characterised by overcapacity. Seat numbers are levelling off in its key long haul market of Latin America, although there is some growth in North America and the 2016 launches of Shanghai and Tokyo routes will feed through to growth in NE Asia this year. In Europe, Iberia is also maintaining flat capacity in the face of rapid LCC expansion.

The second phase of 'Plan de Futuro' targets further margin expansion, but Iberia may have a bigger challenge taking the next step upwards than it did to restore profits. Meanwhile, IAG's growth focus has shifted to its new long haul low cost operator Level.

See related report: Iberia: the Futuro looks bright for IAG's star pupil as its confidence and growth are transformed

2016 was Iberia's third successive positive operating result

Iberia's 2016 results showed that it has consolidated the turnaround achieved under IAG ownership.

Its operating result improved by 24% to a profit of EUR271 million compared with EUR219 million in 2015 (note that the originally reported 2015 result of EUR247 million was lowered after an IAG reorganisation that took the Avios loyalty scheme out of Iberia and British Airways to make it a separate business, with no impact on the underlying profitability of the core airline businesses).

The improved operating result was achieved in spite of a 2.4% fall in revenue, so that Iberia's operating margin gained 1.2ppts to 5.9%. The positive result was Iberia's third in a row, after five successive years of losses in the period 2009 to 2013.

Iberia revenue and operating result (EUR million) 2007 to 2016

Iberia is no longer IAG's worst performer

Although Iberia's operating margin improved in 2016, it remained lower than those of its sister airlines British Airways, which achieved a 12.9% margin, and Aer Lingus, which made 13.2%. Moreover, while BA and Aer Lingus made record high margins, Iberia's 5.9% remained below its 1998 peak of 7.9%.

Nevertheless, Vueling's decline in margin to 2.9% (down 5.3ppts) meant that Iberia was no longer the least profitable airline in IAG.

The operating margin ranking of IAG's airlines was also reflected in their return on invested capital (ROIC) performance. Iberia's 2016 ROIC of 9.0% was ahead of Vueling's 7.3%, but below BA's 13.5% and Aer Lingus' 23.1%. It was also below IAG's target of 15% and its estimated cost of capital of 10.0%.

See related report: IAG faces challenge to maintain momentum in financial performance

IAG operating airlines return on invested capital: rolling four quarters 4Q2015 to 4Q2016

Iberia's post restructuring return to capacity growth is slowing

Iberia's ASK capacity growth slowed to 4.0% in 2016 after 10.2% in 2015 and is planned to slow further to 2.5% in 2017. In 1Q2017, ASKs grew by 3.0%.

After four successive years of capacity growth, its total ASKs will be 22% higher than their 2013 low point in 2017. However, ASKs will still be 4% below their pre-crisis peak level of 2007, after which Iberia cut capacity by 21% through to 2013.

Iberia available seat kilometres (ASK, million) and passenger load factor (%) 2007 to 2017e*

 

At IAG's Capital Markets Day in Nov-2016, Iberia said that its planned compound average growth rate in ASKs from 2015 to 2020 would be 4.0% pa, an increase of 22% over five years. This compares with its Jul-2015 plan of 7.0% pa, an increase of 40% over five years (this had been increased from an earlier plan of 6.5% pa).

The lower capacity growth plan reflects a more uncertain market environment and weak unit revenue conditions. Under the 4.0% pa growth plan, Iberia should exceed its 2007 ASK level by 2018.

Iberia's ASK growth plan to 2020

Iberia's load factor trend is improving

Iberia's load factor declined during its capacity reduction years and dipped further in the first year of its return to growth in 2014, when it bottomed out at 78.6%. However, it increased in each of 2015 and 2016, when it reached 82.0%.

Its load factor is highest on its long haul network (82.7% in 2016), although this was the only region where load factor has not improved sharply since 2014 (it dipped by 0.5ppts in 2016). Domestic and medium haul routes enjoyed load factor gains of around 4ppts in 2016.

In 1Q2017, Iberia's load factor rose by 1.4ppts to 82.5%.

Iberia passenger load factor (%) by region 2007 to 2016

Iberia's ASKs are more dominated by long haul versus before its restructuring

From 2007 to 2013, Iberia's capacity cuts focused more on its short/medium haul network than long haul. International medium haul ASKs fell by 38% during this period, including a 42% cut in Europe, and domestic ASKs were cut by 54%. These are the markets in which LCC competition was most keen and where Iberia struggled to compete.

By contrast, its long haul ASKs were reduced by only 4% from 2007 to 2014, although this disguises a 14% increase from 2007 to 2011, followed by a 15% cut from 2011 to 2013.

From 2007 to 2013, international medium haul's share of Iberia's ASKs fell from 25% to 20% and the share of domestic ASKs fell from 17% to 10%. At the same time, long haul increased its share from 57% to 70%.

Since 2013, medium haul ASKs have grown most rapidly, increasing by 35% to 2016, mainly thanks to a 42% increase in Europe (domestic growth was only 17%). Medium haul accounted for 22% of ASKs in 2016, while domestic ASKs remained at 10%. Long haul ASKs have grown by 15% and their share has dipped to 68%.

The more rapid bounce back by Iberia in Europe is partly a mathematical reflection of the greater capacity cut in the years of shrinkage. It also reflects its efforts under IAG to become more competitive, in particular with the launch in 2013 of Iberia Express.

Nevertheless, the past decade has seen Iberia skew the balance of its network, in ASK terms, firmly towards long haul. In the broader context of IAG, Vueling has been able to fulfil the role of short/medium haul point to point operator very successfully, allowing Iberia to focus its domestic and European network more on long haul hub feed.

Iberia percentage of available seat kilometres (ASK, million) by region 2007 to 2016

Iberia's most important long haul region is Latin America, followed by N America and then NE Asia

Iberia's own annual traffic reporting does not break down its long haul, but the chart below shows the breakdown of its international ASKs in summer 2017 (based on OAG data for the week of 31-Jul-2017). This highlights the strong westward bias of Iberia's long haul network.

Latin America is its most important long haul region, accounting for 52% of its international ASKs, comprising Upper South America (17%), Lower South America (15%), Central America (15%) and Caribbean (5%). North America accounts for 19% of its international ASKs and is its number two long haul region.

Elsewhere in long haul, its 2016 launch of Shanghai and Tokyo routes has brought North East Asia into Iberia's network, accounting for 5% of international ASKs in the week of 31-Jul-2017. Southern Africa accounts for 1% of international ASKs, following Iberia's return to Madrid-Johannesburg in Aug-2016.

(The balance of its international ASKs is completed by North Africa, Central/Western Africa and Middle East, each with a 1% share).

Iberia international ASKs by region week of 31-Jul-2017

Iberia's long haul network is almost entirely Latin America, North America and North East Asia. The next charts show the development of its weekly seat capacity in these regions since summer 2014.

Latin America: Iberia's growth has levelled out

Latin America is its greatest asset. It is the biggest airline by seats between Spain and Latin America and number two between Europe and Latin America, behind Air France. If the Caribbean is excluded, Iberia is number one on Europe-Latin America by seats.

However, having returned to growth on Latin American routes in 2014 and 2015, Iberia's capacity was more stable in 2016, while its main Spanish rival Air Europa has continued to grow. Iberia is pausing as a result of a soft LatAm macro environment and remains cautious even as Brazil's outlook is improving.

Iberia hopes that its new premium economy product, to be launched in May-2017, will help to differentiate it from competitors and, presumably, drive further traffic growth through load factor gains in its long haul network.

According to data from OAG, Iberia's weekly seat capacity to Latin America in the week of 31-Jul-2017 will be only 1% higher than it was two years previously, whereas Air Europa will have increased its seat numbers by 22%.

See related reports:

Air Europa Part 1: Latin America drives growth. Iberia and new entrants provide challenges

Air Europa Part 2: a record of labour productivity gains, CASK near LCC levels but RASK falling

Spain to Latin America: weekly one way seats by airline 21-Apr-2014 to 9-Oct-2017

Long haul growth driven by North America expansion and Asia launches

With little growth on routes to Latin America, Iberia's overall long haul growth slowed in 2016, when long haul ASKs were up by 3.7%, after a 7.7% increase in 2015. What growth there was in 2016 was driven by expansion in North America and the return to North East Asia.

These two regions also look set to drive its long haul growth in 2017. The Johannesburg route, launched in Aug-2016, will also be visible in its long haul capacity growth in 2017 as it operates for a full year for the first time.

On Spain-North America, Iberia's weekly seat capacity more or less tracks that of its oneworld JV partner American Airlines. In the week of 31-Jul-2017, both will have around 10% more seats than in the same week a year earlier and 17% more than in the same week of 2015. They are each roughly twice the size of the nearest rival on Spain-North America, Delta, which is reducing capacity this summer.

Iberia's North America growth this year reflects the first full year of its new Madrid-San Juan route, launched in May-2016.

Spain to North America: weekly one way seats by airline 21-Apr-2014 to 9-Oct-2017

In North East Asia, Iberia launched Madrid-Shanghai in Jun-2016 and Madrid-Tokyo in Oct-2016, taking it from nowhere to the number one airline in this market. It is the only operator on Mardrid-Tokyo, while China Eastern launched Madrid-Shanghai at the same time as Iberia.

See related report: Iberia to launch Tokyo & Shanghai in Asia return after many years. Another sign of approval from IAG

Iberia's capacity will remain flat, while growth this summer by oneworld's Cathay Pacific (with the launch of Hong Kong-Barcelona) and Air China (launch of Shanghai-Barcelona and increased capacity on Beijing-Madrid) will push Iberia into third place on Spain-North East Asia.

Spain to North East Asia: weekly one way seats by airline 21-Apr-2014 to 9-Oct-2017

Spain-Europe: Iberia's post restructuring return to growth has levelled out

Iberia's post restructuring return to growth on routes to Europe mainly took place in 2014 and 2015, but slowed considerably in 2016. During its restructuring years, rapid growth by Ryanair, Vueling and easyJet overtook it in terms of seat numbers and, in spite of the return to growth, it is only the number four airline by seats on routes between Spain and Europe.

OAG data for the last week of July show seat growth of 5% in summer 2016, compared with 20% in 2015. Data for the week of 31-Jul-2017 indicate a 1% cut in seat numbers for Iberia on routes between Spain and Europe (not that Iberia Express is included in these data).

Meanwhile, market leader Ryanair continues to grow strongly (seat numbers up 12% in summer 2017 after 12% in summer 2016). Second ranked easyJet is also growing steadily (seat numbers up 9% in summer 2017 after 6% in summer 2016), while Vueling's 4% capacity cut in this market this summer drops it back into third place as it focuses on its own cost efficiency and restructuring drive.

See related reports:

Vueling NEXT Part 1: return on capital falls to make IAG's LCC the group's poorest performer

Vueling NEXT Part 2: new CEO to lead IAG's LCC in restructuring bid to achieve IAG targets

The Spain-Europe market overall has received significant increases in capacity over the past two years as a result of a number of (mainly leisure) non-Spanish airlines' switching of capacity away from geopolitical hotspots in the Eastern Mediterranean.

See related report: Spain aviation and LCCs: 2016 traffic above pre-crisis levels, but capacity surplus unsustainable

Spain to Europe: weekly one way seats by airline 21-Apr-2014 to 9-Oct-2017

Iberia's share in Spain is lower than other leading European 'flag carriers' in their respective countries

Ranked by total seat numbers (based on OAG data for the week of 31-Jul-2017), Iberia is the number three airline in Spain, with 10% of seats compared with 17% for leader Ryanair and 13% for number two ranked Vueling.

Among Western Europe's larger nations, this gives Iberia the weakest share for a 'flag carrier' in its own country. Using OAG data for the week of 31-Jul-2017, BA is number one in the UK, with 17% of total seats; Lufthansa is number one in Germany, with 29%; Air France is number one in France, with 27%; and Alitalia is number two in Italy, with 15% (behind Ryanair on 22%).

Spain: top 15 airlines by seats week of 31-Jul-2017

Rank

Airline

Seat share

1

Ryanair*

17.2%

2

Vueling

12.6%

3

Iberia

10.3%

4

easyJet*

7.2%

5

Air Europa Lineas Aereas

4.5%

6

Jet2.com*

3.5%

7

NIKI*

3.4%

8

Norwegian Air International*

3.2%

9

Thomson Airways*

2.8%

10

Eurowings/Germanwings*

2.0%

11

Monarch Airlines*

2.0%

12

Lufthansa*

1.7%

13

British Airways*

1.7%

14

Transavia*

1.7%

15

Thomas Cook Airlines*

1.4%

 

All others

24.6%

Iberia's challenge is to take the next step up

Market share is by no means all important, particularly in markets where there is overcapacity, and Iberia's share in Spain must also be viewed at least partly in conjunction with fellow IAG airline Vueling's share.

Moreover, most of the bigger competitors in Spain are short/medium haul specialists, while Iberia's greater strength is long haul.

On the other hand, long haul requires feed from short/medium haul and the main long haul competitor to Iberia in Spain (Air Europa) is growing faster than it currently.

IAG's new long haul low cost operator, Level, also gives long haul options on a group-wide basis. Moreover, Iberia is to provide the aircraft and crew for Level's operations, at least initially.

See related report:

"Level": IAG's new long haul low cost brand to launch 4 routes from Barcelona, with more to come

It is early days in the development of Level, but IAG has in the past explicitly linked Iberia's growth to its meeting financial performance targets and it may not be a coincidence that Level's launch comes when Iberia's growth is slowing.

The waves of restructuring and capacity cuts by Iberia, which began with the global financial crisis in 2008 and continued under IAG ownership from 2011 to 2013, certainly led to the restoration of profitability. This was in no small measure due to improved cost efficiency and labour productivity and Iberia still has solid targets for further labour CASK reduction (a 34% cut in 2021 versus 2012).

However, in a year of historically low fuel prices and when at least two of its IAG sister airlines made record margins, Iberia's shortfall to IAG's ROIC targets suggests that it will need to find more from somewhere.

The second phase of its 'Plan de Futuro' targets improved labour productivity (a new early retirement programme is also under consideration) and lower supplier costs. Iberia will also renew the bulk of its long haul fleet by 2020 (replacing A340s with A330s and A350s).

Nevertheless, with its crisis years behind it and Iberia reaching a plateau of mediocre profitability, the challenge will be to find a way to take the next step upwards.

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