Airlines are like grocery stores.
They have particular goods they need to sell before certain dates and at fairly fixed operating costs. The plane is going to leave with 100 people on board, or 50. It is up to the airline to fill enough seats — at high enough prices — to cover costs. It’s not much more complicated than that, though hedging, financing and gearing will inevitably enter into it.
Thus, it is interesting that the idea that the UK’s erstwhile flag carrier, British Airways, may be in real trouble – is finally making mainstream news headlines.
To wit, this story, headlined ‘Could British Airways really go bust or not?‘, from the most recent issue of the Sunday Times:
In recent weeks Walsh has issued dire warnings to staff, saying that almost all the business is unprofitable, the current awful trading situation will only get worse and that the company faces “a fight for survival”.
In an intranet message, the company told workers: “Time is running out.”
So is it really all over for BA? Is the world’s (former) favourite airline, Britain’s (former) national flag carrier and the (former) operator of Concorde really heading for the scrap-heap?
Well yes, it could. It’s currently pulling in revenues of £8.99bn a year and spending £9.21bn a year on things like fuel, staff costs and landing fees. That’s a £220m loss before you factor in all the wonky financial and accounting tidbits like finance income and losses from fuel hedging. Adding those things in actually makes it much worse — a loss before tax of £401m for fiscal-year 2009.
This is an airline that is losing money — not just at a headline net level but also on an operating basis.
At the same time, the company is also experiencing a very public pensions crisis. The deficit is currently £1.46bn according to BA’s annual reports. Depending on the movements of corporate bonds and equities, which govern how the fund is accounted and valued for, it may get higher. So, barring regulatory leniency, BA will have to make additional — probably significant — payments into its scheme.
Inevitably then, BA is burning through its cash-reserves. Here’s the comment from their annual report:
Our cash, cash equivalents and other current interest-bearing deposits at March 31, 2009, were £1,381 million. This was a reduction of £483 million compared with the preceding year. The reduction was mainly due to the operating loss sustained by the significant downturn in the economy, resulting in cash flow from operating activities being insufficient to cover cash used in investing and financing activities.
Cash reserves are very important things for airlines, whose fortunes tend to be extremely cyclical. Strong reserves built up in the good times can help them withstand the lean times in downturns, perhaps even while competitors go bust. This a strategy vocally pursued by European low-cost carrier Ryanair, which has €2.82bn in cash reserves, a fact seemingly not lost on BA management. From BA’s annual report again:
Fare discounting by competitors has historically had a negative effect on our results because we are generally required to respond to competitors’ fares to maintain passenger traffic. A particular threat in the current economic environment is cash rich competitors growing market share and acting irrationally to force other airlines out of the market.
In any case — assuming a cash burn of £2.7m per day in February 2009 (sourced from BA’s own internal staff newsletter) suggests the airline could burn about £1bn a year, giving it roughly a year and a half until reserves run out. That is of course overstated since BA will generate more revenue in the summer months, and it does not include undrawn credit lines and financing facilities, which according to UBS airline analyst Tim Marshall, include:
British Airways detailed the debt repayment schedule in its [March 2009] investor day presentations, showing no more than around £400m until 2017 which is slightly more than £500m. But it also showed that 80% of the capital expenditure had been financed in total, including 100% up to the end of 2013. Apart from the backstop financing for the A380, Boeing 787 and Airbus A320 programmes, BA has two general purpose facilities, one of US$1,430m to June 2013 and one of US$270m to June 2012. None of BA’s facilities have covenants attached to them.
The point, however, is that suppliers, creditors, investors and perhaps even customers, may get antsy long before cash reserves are burned away.
Estimating whether you think BA will actually require more cash in the near future therefore depends on a couple of things; How long you see the current aviation downturn lasting, how low you think fares will go and how high oil prices will get, and – perhaps less saliently but more importantly — how long the market will be comfortable with this type of cash burn.
Despite the not so significant problem of cash burn, the airline remains favoured among some analysts and investors — largely on the basis that either an Iberia merger will come to fruition or the tie-up with American Airlines will get regulatory approval. Even last year, when signs that the airline could be in trouble should have been apparent to investors they — and some analysts — have been slow, reluctant even, to react. Thus British Airways’ greatest strength may be that in the eyes of many it remains the UK’s flag carrier — practically unassailable and with implicit government support.
Talk that the government could step in to help the carrier, albeit mostly from rival Virgin Atlantic boss Sir Richard Branson, is therefore unsurprising, though BA rigorously denies it’s in discussions with politicians.
We would think that before it ever gets to that stage, BA management will be thinking of raising additional funds — either through the debt market, via aircraft financing, selling off assets, deferring capital expenditure, or even a rights issue. In fact, talk that the airline will pursue the latter at some point is gaining some pace. We have heard a possible two-for-five offer at a 20 per cent discount, to raise a bit more than £400m net of expenses, being mooted by aviation insiders.
Neil Glynn, of NCB Stockbrokers in Dublin, meanwhile, is eyeing £500m:BA should raise up to £500m in fresh equity: Greater exposure to the premium market collapse and mounting pension concerns put BA’s balance sheet under more severe pressure than we see at its chief rivals. Following Air France KLM’s €661m convertible bond issue, the board of BA must now consider raising equity. Gross cash should fall to £1.0bn at March 2010 compared to the historical target of £1.8bn, and we feel the market would be receptive to an equity issue to reduce escalating gearing and address the pension deficit.Related links:
A profits engine, or simple engineering at BA? – FT Alphaville
Flying forces – FT Alphaville
British Airways’ pension puff – FT Alphaville
QE and exploding pensions – FT Alphaville
Class struggles at Virgin Atlantic – FT Alphaville
Airline cycles, redux - FT Alphaville
On aerospace over-supply – FT Alphaville