Air France-KLM: A Partnership Which Can Fly Even Higher
Since the marriage of the two flag carriers which created Air France-KLM nearly twenty years ago, a full integration has looked hard to pull off, with little by way of synergies and significant gaps in operations. Bickering between government owners and the unbalanced say on the board have hardly helped. Thanks to the balance sheet strengthening and the surprising improvement in cash generation, CEO Ben Smith may be at last in a position to reap the fruits of his efforts.
The significant disparity between Air France and KLM at the profitability level (1.7% margin vs 7.7% in 2019, respectively) used to be a bone of contention. During the pandemic, the Dutch government and the Dutch branch even sought to protect State Aid funds from misuse by the French entities. Following a series of fleet optimisation and in-depth cost cuts, including the departure of 12% of full-time employees (-16% at Air France and -9% at KLM), Air France contributed a somewhat larger profit than KLM for the first time in the year-end quarter (operating profit of €144m, vs €-2m at KLM) and successfully raised its FY22 operating margin to 3.0% (vs 6.6% at KLM), despite cost inflation and unfavourable fuel prices (in-line with hedging at peers for 2023). As for the group’s low-cost short-haul brand, Transavia, optimising marginal seats (flying larger aircraft in some slot-constrained airports) and expanding the fleet (to over 100 aircraft this year) is expected to prop up earnings at last (-4.5% in 2022, vs 7.5% in 2019).
With the near-full restoration of 2019 capacity by 2023 (the same as IAG whilst Lufthansa lags due to airport disruptions), the group’s 2022 operating profit (€1,194m) was marginally above the 2019 levels, a feat not achieved by its peers. The 2022 margin up 30bp to 4.5% makes the group's mid-term ambitions (7-8% for 2024-26) more convincing. The group has managed to repair its balance sheet through enormous capital increases (€2,256m in May 2022) but has also improved its cash generation. The Net debt/EBITDA ratio was 1.8x at the end of 2022, from 11.0x in 2021 and ahead of the previous projection of 2.0-2.5x. Further repayments of State rescue funding have unlocked more room for manoeuvre on the M&A and dividend payment fronts (albeit not a current priority). Air France-KLM is nominally in a position to consider the potential acquisition of Portuguese TAP as part of an ongoing consolidation wave, e.g. IAG/Air Europa and Lufthansa/ITA.
Shipping capital
Marseille-based CMA CGM, the world’s third-largest container shipping player, became Air France-KLM's third-largest shareholder as of the middle of 2022 with a 9% holding, behind the French and Dutch States. An exclusive partnership over 10 years will start from April as Europe's largest and the world's fourth-largest air freight operator. CMA CGM just delivered its highest-ever profits, the highest in French corporate history, and is accustomed to reinvesting the bulk (over 90%) of its profits. Air France-KLM should be able to capture the benefits of a reference shareholder with very deep pockets.
The Chinese border reopening from January and the resumption of Chinese visas for foreigners from mid-March (business passengers) are expected to have a progressive impact in 2023 (Air France-KLM’s pre-pandemic capacity to Greater China accounted for 8% of total capacity). Flight disruption includes a necessary detour for the European airlines around the Russian airspace (potentially adding 2-3hrs per route), Chinese citizens’ visa requirements (to most countries) and passport issues (might need renewals), as well as airport preparations/adaptations in China. No meaningful moves on the flight schedule have been seen for the past two months but Air France-KLM plans a major capacity increase from this coming July.
KLM
KLM is at odds with the Dutch government. Along with four rivals, KLM is suing the Dutch government concerning flight restrictions at Amsterdam Schiphol airport (annual capacity to be cut by 12% from the current provisional cap to 440k by November 2024 where KLM holds over 60% of the slots) owing to noise and environmental concerns. While the Dutch government has accused its national carrier of failing to achieve the 2022 cost reduction targets agreed to secure the pandemic-driven State Aid, KLM’s argument of a changed macro environment is not unreasonable. KLM and its alliance hope to win the legal battle as setting flight caps ought to be considered as an act of last resort according to EU regulation 598/2014 and the Chicago Convention. The departure of the long-standing and well-respected former KLM CEO, Pieter Elbers (over 30 years at the company, of which eight years at the helm), who had always sought to defend KLM’s autonomy, may change relations with both Air France and the Dutch State. The arrival of the new CEO, Marjan Rintel, and the return of Angus Clarke (after an 8-month leave, Ben Smith’s right hand man and one of the key individuals in the group’s strategy implementation) to the group’s CCO position may well help revisit the group’s relationship with the Dutch government and support Ben Smith’s leadership (mandate extended for another five years to 2027) and integration ambitions.
Can fly higher
The potential reversal of the flight cap at Amsterdam Schiphol airport and smoother governance between Air France and KLM are positive background noise. However, the resumption of a dividend payment (suspended since 2008) is likely to be further postponed, despite the lifting of the pay-out limit following the redemption of over 75% of the government support.
The significant disparity between Air France and KLM at the profitability level (1.7% margin vs 7.7% in 2019, respectively) used to be a bone of contention. During the pandemic, the Dutch government and the Dutch branch even sought to protect State Aid funds from misuse by the French entities. Following a series of fleet optimisation and in-depth cost cuts, including the departure of 12% of full-time employees (-16% at Air France and -9% at KLM), Air France contributed a somewhat larger profit than KLM for the first time in the year-end quarter (operating profit of €144m, vs €-2m at KLM) and successfully raised its FY22 operating margin to 3.0% (vs 6.6% at KLM), despite cost inflation and unfavourable fuel prices (in-line with hedging at peers for 2023). As for the group’s low-cost short-haul brand, Transavia, optimising marginal seats (flying larger aircraft in some slot-constrained airports) and expanding the fleet (to over 100 aircraft this year) is expected to prop up earnings at last (-4.5% in 2022, vs 7.5% in 2019).
With the near-full restoration of 2019 capacity by 2023 (the same as IAG whilst Lufthansa lags due to airport disruptions), the group’s 2022 operating profit (€1,194m) was marginally above the 2019 levels, a feat not achieved by its peers. The 2022 margin up 30bp to 4.5% makes the group's mid-term ambitions (7-8% for 2024-26) more convincing. The group has managed to repair its balance sheet through enormous capital increases (€2,256m in May 2022) but has also improved its cash generation. The Net debt/EBITDA ratio was 1.8x at the end of 2022, from 11.0x in 2021 and ahead of the previous projection of 2.0-2.5x. Further repayments of State rescue funding have unlocked more room for manoeuvre on the M&A and dividend payment fronts (albeit not a current priority). Air France-KLM is nominally in a position to consider the potential acquisition of Portuguese TAP as part of an ongoing consolidation wave, e.g. IAG/Air Europa and Lufthansa/ITA.
Shipping capital
Marseille-based CMA CGM, the world’s third-largest container shipping player, became Air France-KLM's third-largest shareholder as of the middle of 2022 with a 9% holding, behind the French and Dutch States. An exclusive partnership over 10 years will start from April as Europe's largest and the world's fourth-largest air freight operator. CMA CGM just delivered its highest-ever profits, the highest in French corporate history, and is accustomed to reinvesting the bulk (over 90%) of its profits. Air France-KLM should be able to capture the benefits of a reference shareholder with very deep pockets.
The Chinese border reopening from January and the resumption of Chinese visas for foreigners from mid-March (business passengers) are expected to have a progressive impact in 2023 (Air France-KLM’s pre-pandemic capacity to Greater China accounted for 8% of total capacity). Flight disruption includes a necessary detour for the European airlines around the Russian airspace (potentially adding 2-3hrs per route), Chinese citizens’ visa requirements (to most countries) and passport issues (might need renewals), as well as airport preparations/adaptations in China. No meaningful moves on the flight schedule have been seen for the past two months but Air France-KLM plans a major capacity increase from this coming July.
KLM
KLM is at odds with the Dutch government. Along with four rivals, KLM is suing the Dutch government concerning flight restrictions at Amsterdam Schiphol airport (annual capacity to be cut by 12% from the current provisional cap to 440k by November 2024 where KLM holds over 60% of the slots) owing to noise and environmental concerns. While the Dutch government has accused its national carrier of failing to achieve the 2022 cost reduction targets agreed to secure the pandemic-driven State Aid, KLM’s argument of a changed macro environment is not unreasonable. KLM and its alliance hope to win the legal battle as setting flight caps ought to be considered as an act of last resort according to EU regulation 598/2014 and the Chicago Convention. The departure of the long-standing and well-respected former KLM CEO, Pieter Elbers (over 30 years at the company, of which eight years at the helm), who had always sought to defend KLM’s autonomy, may change relations with both Air France and the Dutch State. The arrival of the new CEO, Marjan Rintel, and the return of Angus Clarke (after an 8-month leave, Ben Smith’s right hand man and one of the key individuals in the group’s strategy implementation) to the group’s CCO position may well help revisit the group’s relationship with the Dutch government and support Ben Smith’s leadership (mandate extended for another five years to 2027) and integration ambitions.
Can fly higher
The potential reversal of the flight cap at Amsterdam Schiphol airport and smoother governance between Air France and KLM are positive background noise. However, the resumption of a dividend payment (suspended since 2008) is likely to be further postponed, despite the lifting of the pay-out limit following the redemption of over 75% of the government support.
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