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IAG - expects return to 50% capacity service in July

Sophie Lund-Yates, Equity Analyst | 7 May 2020 | A A A
IAG - expects return to 50% capacity service in July

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International Consolidated Airlines CDI

Sell: 228.90 | Buy: 229.30 | Change -17.90 (-7.26%)
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IAG has provided more detailed first quarter results, following the trading statement released on 29 April.

The group doesn't expect passenger demand to recover before 2023. IAG is considering a "meaningful return" to service from July 2020, this would see an overall reduction in capacity by around 50%.

To boost liquidity, IAG has accessed the UK's Coronavirus Corporate Finance Facility (CCFF) and Spain's Instituto de Crédito Oficial ('ICO') facility.

The disruption means further group-wide restructuring will be necessary. The difficult conditions mean CEO Willie Walsh has postponed his retirement until September.

The shares rose 2.7% following the announcement.

View the latest IAG share price and how to deal

Our view

Coronavirus has hit airlines hard.

Demand for flights has dropped substantially as travel restrictions rippled across the globe. Worryingly, IAG thinks it will take "several years" for demand to recover to 2019 levels. That means IAG and its peers are being forced to take a long hard look in the mirror, and introduce some painful cuts if they want to survive the disruption.

IAG plans to do this through further restructuring, as well as making up to 12,000 British Airways staff redundant.

In times like these investors will be thinking hard about the financial strength of the businesses they own. The two key metrics are therefore the amount of money going out the door, and the amount of liquid cash the group has to meet its obligations.

The group has access to EUR10bn when needed. Over half of this is cash, and the rest is undrawn credit. The group raised EUR1.3bn from government lending schemes in the UK and Spain since the end of March, and from this we're able to see that the group is using about EUR800m of cash a month. That fits with IAG's claims it's reduced cash costs to about EUR200m a week, which is less than half the usual levels. We also suspect that as things progress these costs should be able to come down a bit more too.

IAG's significant liquidity puts it in a stronger position than some of its peers, and this is its main attraction in our view. But investors shouldn't lose sight of the fact the short-term earnings hit has been very ugly, and could get worse before better. If the disruption continues long enough even IAG's resources could reach their limit.

We don't know where this will end up, but the risk-reward profile of the airlines has been heightened dramatically by COVID-19. It is possible that some airlines will not make it through this degree of disruption, especially if it continues for an extended period of time. However, those that do make it could see their competitive position strengthened in the end.

Investors will be heartened to hear the group plans to get back to some degree of business in the next few months, but the aviation industry is going to be a much smaller affair for quite some time.

We think IAG stands a better chance of surviving than some peers, but this depends on how the outbreak progresses, and how long the economy takes to recover. One thing we can guarantee is we will be looking at a very different business on the other side of this storm.

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Further first quarter trading details

The 13.4% decline in total revenue was driven by a fall of 14.5% in overall passenger revenue to €4.0bn. Passenger revenue per available kilometre declined 7.7%, ignoring the impact of exchange rates.

Revenue from cargo was down 11.6% because of the outbreak, especially because of the effect on markets in Asia Pacific.

Non-fuel costs increased 15.1%, which reflects the sharp reduction in capacity. Employee costs rose 2.5%, as IAG had increased resources to prepare for the anticipated increase in passengers. The furlough and salary reduction programmes were applied at the start of April, so are not reflected in these numbers.

Underlying fuel costs fell 11.5% because of the reduced number of flights.

For April and May cash operating costs have been reduced from €440m per week during normal times, to €200m per week. At the same time, capital spending has been reduced by €1.2bn, and the majority of the remaining €3bn is covered by agreed financing.

Because of the expected longer-term drop in passenger demand, IAG expects to defer delivery of 68 new aircraft.

Iberia and Vueling have secured access to new financing of €750m and €260m respectively. The agreements are part of the Spanish government's lending programme, and 70% of the loans are guaranteed. One of the terms set by the lenders, known as covenants, is that IAG will not use these funds to support its other companies.

As a whole IAG now has access to €10.0bn in cash and undrawn finance facilities, up from €9.5bn at the end of March.

The group reiterated it does not intend to pay the next dividend of €0.17 per share.

First quarter trading statement (29 April 2020)

IAG's first quarter revenue fell 13% to €4.6bn and the group made an underlying operating loss of €535m, compared to a €135m profit in the same period last year.

IAG's pre-tax profit was impacted by a €1.3bn exceptional charge for now ineffective fuel hedges. The group's operating result was in line with last year during the first two months of 2020, and most of the losses were incurred in March. British Airways was the biggest contributor to the losses, followed by Iberia and Aer Lingus. Vueling experienced only a minor increase in losses.

Capacity, as measured by available seat kilometres, fell 10.5% and the planes were on average 76.4% full, a decline of 4.3 percentage points.

IAG has reduced capacity by 94% for April and May, and is only operating passenger flights for essential travel and repatriation.

Trade unions have been notified of the potential for 12,000 redundancies at British Airways.

IAG is not giving detailed profit guidance, but expects losses in the second quarter to be "significantly worse" than those suffered in the first quarter.

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