Profits dangerous for airline business
In the airline business there is nothing more damaging to a company’s internal harmony than making a profit.
In the airline business there is nothing more damaging to a company’s internal harmony than making a profit. The pilot strikes that have grounded almost all British Airways (BA) flights for the next two days are a case in point.
Unlike most industrial sectors, the usual state of affairs for airlines is spending vast sums of money for little return. (Warren Buffett famously opined this makes the sector a trap for
investors.) In one respect this lousy reputation is actually helpful: unionised staff will not drive as hard a bargain for higher wages if they think it might make their employer go bust.
Recently, however, the industry has broken with its dismal profit trend, with returns on capital expected to be positive for the fifth year in a row.
BA parent, International Consolidated Airlines Group (IAG), is a good example. Its net profit rose to €2.9bn in 2018 and the return on invested capital to a very respectable 16.6%, according to the company’s calculation. Hence IAG felt able to return €1.3bn to shareholders in dividends over the past year. Analysts are generally admiring.
Even though many BA pilots are paid well, they feel they have been short-changed and they appear to have the airline over a barrel. Pilots are still indispensable if you want to take off or land a plane. And they can take advantage of BA’s public image being tainted recently by various IT and customer data snafus.
That has fed the perception that the quality of BA ’ s service is not what it was (the airline is celebrating its centenary but there is little talk anymore of it being “the world’s favourite airline”). Pilots are probably betting that the airline will blink first to spare further damage to its image.
Despite the admiration of equity analysts, investors have cause to feel aggrieved too. BA’s strong profit and disciplined capital allocation have not translated into a high share price. The stock has tumbled by one-third over the past year. IAG is valued at just four times its annual earnings, which typically indicates a profit collapse on the horizon. The share price to earnings multiple is worse than that of most airline peers. Even Europe’s maligned carmakers are held in more esteem by shareholders.
And labour strife is not the reason for the company’s unpopularity in the stock market. This week’s strike will cost it about £80m, just 4% of expected yearly earnings. Rather, investors seem preoccupied by the very real possibility of a no-deal Brexit. Demand could suffer if Britain enters a recession and the pound loses even more of its buying power overseas. UK customers account for about one-third of IAG’s revenue.
Furthermore, IAG is based in Spain and it will have to stay compliant after Brexit with the EU rule that requires the continent’s airlines to be majorityowned by EU nationals. IAG has been pretty vague on this subject but it insists Europe’s national regulators are happy with its arrangements. It also insists that a no-deal Brexit would have “no significant long-term impact” on the business.
Investors do not seem ready to believe the company, and who can blame them? In an update on Monday, BA’s rival Air France-KLM sounded gloomy about recent demand for air travel. This is a bad time for the British airline’s repeated bouts of self-harm.