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AFKLM’s ‘Improvement Area’ is AF

06 November 2019 by jbchevrel

Air France-KLM (AFKLM) is the second-largest airline in Europe after LHAGR, flying c100 million customers and c1 million tons cargo each year. Yesterday it was AFKLM investor day. Management presented financial targets for the next 5y. They target an improvement in operating margin to 7-8% (from c.5% currently). This would come mostly from improving AF (op. margin c2%), where profitability lags European peers (IAG LHAGR..) and even KLM, which are high-single-digit or low-double-digit op. margin. Management targets to raise AF op. income +€900M over 5y and boost op. margin from c2% currently to c7%. It looks quite ambitious by just streamlining AF. While this seems behind us when listening to the CEO, we know the social context can be difficult to deal with, making the leeway thinner on a number of variables. I assume some readers had a scheduled AF flight in the spring of last year. I had. AF suffers from a complex unefficient French network and faces fierce competition from high-speed train TGV. in the near term, the credit picture isn’t looking any better, but management guidance, as a whole, can be seen as reassuring. Management guided for higher capex from c€3B now to c€4B per year over 5y mainly to renew the fleet and cut the fleet leasing ratio (leasing ratio would fall 44% -> 33% in 5y, AFKLM would own a higher proportion of their aircrafts). That will surely add to net debt over next 3y. AFKLM management said it remains committed to keep leverage ~1.5x, hoping for profitability improve in parallel. Another not-too-good news for the credit is that management floated the idea to restart paying a dividend. That would be the 1st time since the GFC. The idea would be a 25% payout ratio as soon as op. result tops €1.9B. For reference it closer to €1B last year. So the contingent probability is not 1, and even if that materializes, that would be effectively triggered in 2022-23 only. The macro picture is always bound by pressured revenue/passenger, volatile fuel cost, among others. The idiosyncratic picture has improved a lot since spring last year (5y CDS almost halved from 300bp). But now profitability at AF needs to improve to make management’s target for net adj. leverage 1.5x hit. liquidity is ample: c€7B = c€5.5B C&CE + c€1.5B credit facilities, of which ~1/3 KLM ~2/3 AF. And the group still owns shares in Amadeus (€0.3B) and Servair (€0.2B) that management plans to sell. So clearly not a concern for AFKLM, as the group faces <0.5B maturities in 19, <1.5B in 20/21, mainly asset backed.