Airline Weekly - November 9, 2015
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Airline Weekly - November 9, 2015

Europe’s Four-Headed Monster: It’s oddly paying more for fuel this year than last, but IAG is A-OK

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Cover Story

Europe’s Four-Headed Monster: It’s oddly paying more for fuel this year than last, but IAG is A-OK

Something’s not right here. International Airlines Group, or IAG—the parent company of British Airways, Iberia, Aer Lingus and Vueling—is spending more money on fuel this year than last year. And that was true even in the third quarter alone, when every single other airline in the world that has reported—even those flying a lot more capacity this year than last—saw total fuel costs decline. Oh, the misfortunes of over-hedging.

But that’s not the main story here. On a larger and more important level, something is going very right at IAG, whose performance in recent quarters makes it one of the most profitable airline companies in the world despite those heavy hedge losses. Although sometimes lost amid the U.S. airlines (and China’s unhedged airlines too) reporting ridiculously high profit margins, IAG’s 19% Q3 operating margin nearly equaled those of the U.S. Big Three, never mind the massive fuel cost reductions the Americans enjoyed—especially IAG’s joint venture partner, the hedgeless horseman American. More generally, IAG is not experiencing the revenue plague afflicting the majority of large intercontinental airlines, IAG’s chief rivals Lufthansa and Air France/KLM included. No surprise, then, that’s it’s been outperforming many of the world’s top global carriers this year. In the past 12 months, in fact, it earned more than $2.3b in operating profits, good for a 9% operating margin—and let’s remember one more time: That’s with awful hedge positions for the entire period.

In a review of its business for investors last week, IAG talked at length about what’s gone right and why it thinks there’s lots of room to increase profit margins even further. As it happens, the confluence of favorable trends is remarkable. IAG’s four main hubs—London, Madrid, Barcelona and Dublin—are located in three of the fastest growing economies in Europe. But more important is its outsized exposure to the strong U.S. market—IAG flies more seats to the U.S. than any other foreign airline group except Air Canada.

Just as important is what IAG is not exposed to. Far from being the threat they are to Lufthansa and Air France/KLM (and so many other legacy airlines), Gulf carriers largely don’t touch IAG’s main traffic base, i.e., that between Europe and the Americas, or even between Europe and northeast Asian economic centers like Tokyo, Beijing, Shanghai and Hong Kong. Of course, largely because London is the world’s biggest airline market, IAG’s overall network is less dependent on connecting traffic anyway, which means less traffic flow subject to diversion... (432 of 1,727 words)

Also Inside this Issue:

In the past 10 years, the world has turned upside down. And that’s bad news for Emirates and Turkish Airlines, which miss the way things used to be. Emerging markets, including their home countries, are no longer enjoying the epic economic boom that characterized the mid-2000s. Today, both airlines remain profitable, powerful and expansionary. But Emirates earned uninspiring margins this summer, and Turkish Airlines—although its Q3 was strong as usual thanks to momentarily favorable conditions in Europe—faces revenue meltdowns across the globe, a trend that bodes ill for the winter.

The story isn’t all that different for Singapore Airlines, another carrier uncomfortable with the current state of the world. Its revenue distress isn’t quite so bad—thankfully, the important Chinese market is holding up well. But like a hungry man who arrives at a restaurant only to find it closed, Singapore Airlines encountered a feast of cheap fuel, only to see the entrance to the party blocked by a large pile of toxic fuel hedges. The end result was a painfully small operating profit.

U.S. airlines, of course, are happy about the world turning upside down from where it was 10 years ago. Their market is the one that’s now booming. But watch out! Ultra-LCCs are on the move, with Spirit now entering already-competitive Seattle.

It was a bad week for Lufthansa, whose flight attendants staged a strike, and whose distribution strategy showed more signs of backfiring. Southwest unhappily learned its pilots rejected a contract proposal. And airlines are regrettably retreating from Egypt.

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