The contrasting stories of two of Europe’s biggest airline groups
Air France-KLM (AF-KL) entered the COVID crisis in decent shape from a balance sheet point of view. Even before the injection of funds from the French government, the March 2020 cash position was €6.4 billion, equivalent to 23% of 2019 revenues, almost matching the 26% ratio at well capitalised IAG. Net debt of €6.6 billion was actually lower than IAG’s €7.5 billion.
However, it was much less profitable than IAG, with operating margins in 2019 of 4.4% compared to IAG’s 14.8%. This meant that as a ratio to EBITDA, a standard measure of debt affordability, net debt levels were a little higher at 1.6x compared to 1.4x at IAG. But still pretty solid and much better than Lufthansa which had cash levels of only 9% of revenue and net debt / EBITDA of 3.3x.
AF-KL’s profitability had lagged behind IAG’s for many years. So how did it come to be in such a relatively solid position from a balance sheet perspective? To answer that, we need to look back at the last few years of history, because the two companies have been on very different tracks.
The back story
Since 2015, IAG has returned €4.1 billion of cash to shareholders in the form of dividends and share buybacks. It also spent €1.4 billion buying Aer Lingus and had to put €3.3 billion into plugging the historic pension fund deficit at BA, totalling over €8 billion of cash outflows.
AF-KL is almost a complete mirror image. It hasn’t paid a dividend since 2008 and since 2015 has raised €1.3 billion of new equity (€751m from industry partners Delta and China Eastern plus the conversion of bonds into €523m of equity). It generated €1.3 billion from disposals (mostly €884m of Amadeus shares and a €246m sale of LHR slots to Delta), giving total cash inflows of €2.6 billions.
So IAG has been buying things and returning money to shareholders whilst AF-KL has been selling things and raising new capital. The result is that despite the fact that AF-KL was slightly bigger than IAG in revenue terms, prior to the COVID induced sell off in all airline shares, IAG’s market capitalisation stood at 3.5 times that of its less shareholder-friendly and profitable rival. If it hadn’t been for the drag of BA’s historic pension fund deficit, the difference would have been even starker.
The immediate COVID response
The other big difference has been the two companies’ response to the COVID crisis. At the end of March 2020, IAG still had access to €2.6 billion of undrawn facilities, whilst AF-KL had drawn all of its remaining facilities and still had less cash than IAG. AF-KL went straight to the French and Dutch governments of course and was rapidly granted €7 billion of state or state backed loans by the ever helpful French government, with the potential for another €2 to €4 billion to come from the somewhat more reluctant Dutch state. IAG got €1 billion of loans backed by the Spanish government and €300m from the UK, giving it €10 billion of liquidity at the end of April. At the same date, I estimate AF-KL had secured €12.9 billion of liquidity and were looking to raise another €2-4 billion from the Dutch government.
So why does AF-KL need €5-7 billion more liquidity than IAG says it does? That is a question that I am sure the Dutch state is also trying to get answered.
The next few months
The answer doesn’t seem to lie in the cash requirements of the next few months. With revenue effectively wiped out for both companies, the cash requirements are driven by 1) the level of cash costs during lock-down 2) any immediate loan repayments required and 3) working capital effects. Let’s take them in turn.
For IAG, as I outlined in this article, I think the monthly cash burn is in the €800 – €900m range, quite similar to the figure given by Lufthansa. In their Q1 results announcement, AF-KL quoted a monthly cash burn of €400m, which seems oddly small for a company with slightly higher “normal” cash operating costs (€1.9 billion a month versus €1.7 billion at IAG). One factor will be the better fuel hedging position, with AF-KL disclosing a €455m “ineffective fuel hedge” loss compared to over €1.3 billion at IAG. That will turn into cash over the remainder of 2020. Another factor is undoubtedly the €570m of tax and social charges payments which were disclosed to have been “deferred beyond 2020”, once again thanks to the largesse of the French government. There is something of a pattern developing here.
When it comes to loan repayments, at the end of March AF-KL showed €900m of debt repayments due for the remainder of 2020. IAG don’t give a figure for this, but at the end of December 2019, the current portion of their long term debt (which means it was due in 2020) was shown as €1.8 billion, so perhaps €1.4 billion for the April – December period. So on the face of it, that doesn’t seem to explain it either. Much of these “loan repayments” are actually lease obligations and I’m guessing that IAG, with its much better financial track record, will have been able to secure deferrals on much of this. That won’t have been the case I think for AF-KL, in large part because the lessors will have known that the French state would step in.
Finally, working capital requirements. One of the biggest items here is deferred revenue on ticket sales. This is money that airlines have received from customers for future travel. With much of those bookings on flights that have been cancelled, there is a potentially big cash outflow from refunds during a period when no new bookings are coming in. These are big numbers. For IAG at the end of December 2019, this item stood at €5.5 billion. Perhaps there is a difference here which might explain why AF-KL needs more liquidity? In fact, the corresponding figure for them was only €3.3 billion. Maybe they are being more helpful in allowing cash refunds, rather than insisting on vouchers? Nope. In response to questioning from UK politicians during a Select Committee hearing, Willie Walsh said that IAG had already made refunds totalling €1.1 billion by early May. In contrast, AF-KL were singled out by consumer watchdog Which? for “… not just delaying refunds but flatly refusing them”.
Beyond the immediate crisis
So what is the real reason that AF-KL has secured so much extra liquidity at the taxpayer’s expense? I think that IAG is determined to take the necessary steps to get back to profitability quickly and is being vilified by UK politicians for doing so. In contrast, AF-KL knows that it cannot do so (it was barely profitable even before the crisis) and isn’t going to rock the boat with its political paymasters by even trying.
One final thought. Shareholders in AF-KL should take note that almost all of the largesse from the French state has come in the form of loans and tax deferrals, which will need to be repaid or refinanced with equity at some point. Given the awful track record of the company when it comes to how it treats shareholders, I would suggest that the 3:1 ratio of the current market capitalisations of the two companies might not be representative of the proper relative valuations.
By way of fair disclosure, I am a shareholder in IAG and do not own any AF-KL shares. I’m not that stupid.