IAG profit growth a positive but unsustainable performance in a tough 2012 for European airlines.
Today IAG announced its 2011 annual results, characterised by a doubling of operating profits from €225 Million to €485 Million. However, we expect the tough economic climate to negatively impact all European airlines in 2012.
This year European airline consolidation will intensify, with airline groups actively looking for opportunities to enhance their operations and bring economies of scale. The driver for consolidation is the worsening European economy, rising fuel prices, low cost carrier growth and the lack of financing for organic growth. In these situations, large network carriers tend to benefit. Among these, IAG is in a position, both financially and strategically, to take advantage of economic conditions and acquire niche players at bargain prices. If we look at the two companies in play, Aer Lingus and TAP, and exclude BMI which is an opportunistic acquisition, TAP seems to offer more network synergies with BA and Iberia. Aer Lingus is an airline in transition and apart from being part of the oneworld alliance, it is not an attractive target.
In late 2011 IAG released some early performance indicators on the success of the BA-Iberia merger and seems to be on target, even though it has chosen to set itself very low targets to begin with. Shareholder value cannot be realised at such a short period following a merger. In the case of the 2003 AF-KLM merger, it took the combined entity a number of years to produce any meaningful synergies. In cross-border M&A and more specifically in the airline industry, it is normal to have unexpected delays in synergy realisation, due to labour disputes, Government intervention and change resistance. Nonetheless, we have to put everything into perspective. It is far easier for IAG to realise benefits from an acquisition of a much smaller player, like TAP, than achieve full synergies from a merger of equals.
When discussing airlines, we have to mention the effect of rising jet fuel prices, which are indeed a systemic risk in the airline market. Since the year 2000, jet fuel prices have tripled, while fuel costs have grown from 15% to 30% of total operating costs. A steep increase in any given year will, with near certainty, have a major impact on airline profitability, whatever the hedge coverage. Particularly for IAG, fuel hedging is expected to be around 50% this year, compared to 70% last year.
Few airlines get it right when it comes to fuel hedging and IAG is not an exception. Fuel hedging is a practice that adds some level of certainty in an unknown and highly volatile variable, but overall it has proven an unreliable risk hedging tool in itself. This is why airlines rely more on fuel surcharges, as opposed to hedging policies, in an attempt to pass on the costs to their customers.
To conclude, larger airlines like IAG have more firepower to withstand sharp periodic fuel price increases, like the one in the first half of 2008. Prolonged increases however, such as the one witnessed throughout the last decade, require more fundamental changes in airline business models.