You don’t know what you’ve got till it’s gone

Many people have commented on the difference between the the amount of money which Germany has put behind their main airline group Lufthansa, compared to what has been done by the governments of the UK and Spain for IAG. I thought I would have a look at the figures to explain why Lufthansa needed the support and IAG could avoid going “cap in hand” to the government for a bailout, and also to look at where the huge bailout for Lufthansa leaves IAG from a competitive point of view.

In the case of Lufthansa, a bespoke €9 billion “stabilisation package” has been assembled, all backed by the German government, About 55% of this is in the form of equity from the government, with 45% in the form of government backed debt. For IAG, they have had access to the government guaranteed COVID loan schemes in the UK and in Spain which were available to all companies, adding up to “only” €1.3 billion.

Given the huge disparity, where does that leave the two companies in relative liquidity terms? IAG started from a much healthier position, with liquidity of €9.5 billion at the end of March compared to €4.25 billion at the larger Lufthansa. However, despite being smaller than Lufthansa, IAG seems to me to be burning cash at a somewhat higher rate currently.

It is difficult to compare the companies as they quote figures on a different basis. In their Q1 2020 releases, Lufthansa gave a cash burn figure of €800m a month, whilst IAG cited “normal run-rate cash operating costs” of €200m a week, or €857m a month. To put the IAG number onto a more comparable basis to Lufthansa’s figure, you need to make two main adjustments. Lufthansa’s number includes fuel hedging losses, whereas I believe that IAG’s does not. IAG declared “ineffective fuel hedging” losses of €1.3 billion, versus €950m for Lufthansa. This seems to reflect IAG being more highly hedged in the near term than Lufthansa was. In any case, a large part of the hedging losses will materialise in cash terms in Q2, which will increases IAG’s cash burn in Q2 by around €270m a month based on my estimates. The other adjustment needed is to include the revenue that is being earned. With flights operating at around 10% of normal capacity in Q2, that will be a fraction of the usual €2 billion a month that IAG would normally generate in Q2. However it probably adds about €165m a month, taking IAG’s monthly cash burn to €962m on the same basis as Lufthansa.

So let us do a crude calculation of the predicted liquidity position of IAG and Lufthansa at the end of Q2, by which time both companies are expected to have recommenced “a meaningful operation”. Lufthansa will have liquidity of €4.25 billion (the March position), plus the €9 billion stabilisation package, less three months of cash burn at €800m a month giving €10.9 billion. IAG gave a figure of €10 billion for their liquidity at the end of April, which I think went up from up €0.5 billion from the position at the end of March due to €1.3 billion raised from the UK and Spanish governments, offset by cash burn for April. That suggests a cash burn in April of €836m, slightly below the figure I calculated above. By the end of Q2, they will have burned another €1.9 billion, giving them €8.1 billion. Expressed in terms of their “normal” cash operating expenses when operating at full capacity (where Lufthansa is 1.7x the size of IAG), this gives Lufthansa 115 days of liquidity compared to IAG’s 147 days. Of course they both have many more days of liquidity than this, as this metric assumes zero revenue and full operating costs, but it is a good basis on which to compare the two companies.

Given the amount of assumptions that have gone into these calculations, my conclusion is that both companies will start the third quarter with similar levels of liquidity compared to the size of their pre COVID cost bases, with IAG in a somewhat better position (c 25% better). The big difference, of course, is how much backing it will have required from governments to get to that position. For Germany, it took €9 billion, compared to €1.3 billion for IAG, of which the UK government has only provided €0.3 billion.

I think that UK Government MPs, who have been very critical of British Airways and IAG, would do well to reflect on these differences, As well as being thankful for their good fortune in having such well capitalised airlines based in the UK, I would suggest that they could consider being more helpful going forward if they don’t want to see the lead that UK airlines had over their European rivals going into this crisis being squandered as a result of COVID and the different policy responses.

It should be the case that as the lower cost and more profitable operator pre COVID, IAG should be able to get back to profitability and cash generation at a faster rate than Lufthansa. However, the UK government seems to be doing its best to offset this advantage by the inept way in which it is dealing with the resumption of air travel. The ill thought through introduction of quarantine requirements for arrivals into the UK, just as other countries are relaxing theirs, is the current prime case in point.

I hope this won’t be another example of the UK failing to realise that “You don’t know what you’ve got till it’s gone”. We no longer have a car industry to speak of due to government neglect. Let’s not let the UK’s previously strong global position in the airline and aerospace industries be casualties of this dreadful crisis.