Airline Weekly - October 24, 2011

Cover Story

French Flies: Air France is sick, and the low-cost carriers buzzing throughout France are one reason why

For the low-cost airline that’s “painting Europe orange,” no market has higher priority than France, the land of 246 different cheeses. EasyJet, perhaps, should change its name to cheesyJet. But an irresistible opportunity for one airline is a dangerous liability for another, namely Air France/KLM. As its board of directors recognized last week, Air France in particular has major problems, and shorthaul exposure to LCCs is among the most serious.

Why, exactly, did Air France/KLM’s board of directors fire its CEO last week? To answer that question, just look at Air France/KLM’s recent financial results. During the calendar year 2009, it lost nearly $1.6b ex special items, more than any other airline on earth except Japan Airlines. Last year, one of the best ever for the airline industry thanks to stable fuel prices, recovering demand and constrained supply, Air France/KLM suffered an ex-items loss of nearly $500m. And so far this year, in just six months, it lost more than $600m—even American had a better operating margin. Accordingly, the company’s stock price is down almost 60% y/y. That’s far worse, predictably enough, than more profitable rivals Lufthansa and BA/Iberia. What’s going on?

To some degree, Air France/KLM’s predicament comes down to a simple case of bad luck. It’s had by far the worst fuel hedge position among peers, producing, for example, just $135m in gains during the second quarter, compared to $239m for BA/Iberia and $367m for Lufthansa. Its luck wasn’t any better in the area of crisis exposure. Political disruptions in former French colonies like Tunisia, Syria and the Ivory Coast, for example, left it with outsized losses. Air France/KLM also has more exposure than its Big Three rivals to Japan if you include equity partner Alitalia (5.6% of total ASKs at the time of the earthquake, slightly above Lufthansa’s 5.4% figure, including Swiss and Austrian). These disruptions, incidentally, also caused first-half losses at the company’s Transavia and cargo units. Air France, tragically, also suffered a fatal plane crash in 2009, which surely impacted earnings as well.

Taking a closer look at Alitalia, Air France/KLM’s 25% ownership stake forced it to eat a chunk of the carrier’s $130m net loss during the first half of 2011 in addition to its $225m net loss last year. To this you can add the broader set of woes facing all European airlines during the past couple of years: freakishly bad winter weather, labor strikes, a fluctuating euro, a spike in fuel prices, expensive new security directives, volcanic ash clouds, an onslaught of new capacity from Arabian Gulf carriers, higher taxes, a spreading fiscal and financial crisis and weak economic growth.

But there’s not much Air France can do about dumb luck with fuel hedging, market disruptions and a souring economic environment in Europe. Its exposure to labor unrest has (488 of 1,952 words)

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At least you could see it coming. American’s third quarter earnings were bad, even worse than Wall Street expected. But with fuel prices way up and new labor contracts still elusive, good news would have been more surprising.

One facet of American’s strategy that did raise eyebrows last week: its war on global distribution companies. To the extent that you can say something without saying something, American strongly hinted that its revenues were severely impacted by what it alleges was an illegal boycott organized by Sabre. Now it’s up to the courts to decide if it’s right, and for American itself to decide if its war is worth the blood and treasure.

Three other U.S. airlines joined American in reporting Q3 results last week, and all three reported more treasure than blood. Southwest did technically report a net loss due to accounting gobbledygook. But buried underneath was a solidly profitable quarter, albeit less profitable than last year and less profitable than normal for the peak summer period. The simple reason why? Another fuel spike.

Alaska Airlines, meanwhile, had another great quarter, and so did Hawaiian. And all four reporting U.S. carriers spoke of ongoing revenue and demand strength.

Across the pond in Europe, Norwegian Airlines had an excellent summer quarter. And farther east, Korean Air did reasonably well despite the fuel spike and a cargo slump.

Elsewhere, labor woes continued at Qantas, China Eastern canceled B787 orders and Frankfurt’s airport opened a long-awaited new runway.

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