Air France-KLM
Equity Research
Transport / France
Report
EPS revisions
03/07 03/08e 03/09e 03/10e
Revised
Previous
% change
3.03
3.03
-
3.68
3.68
-
4.36
4.53
(4)
4.46
5.21
(14)
20 November 2007
Market cap./Free float (EURbn)
EV (EURbn)
12-month high/low (EUR)
Reuters/Bloomberg
DJ STOXX50
Risk rating
Per share data (EUR)
EPS restated
EPS reported
EPS (IBES)
CFPS
Net dividend
6.7/5.5
14.5
38.3/22.6
AIRF.PA/AF FP
3,660.0
D
03/07 03/08e 03/09e 03/10e
3.03
3.68
4.36
4.46
3.32
4.70
4.24
4.35
3.35
3.45
3.73
3.96
9.54 10.41 10.52 10.81
0.48
0.54
0.64
0.74
Stockmarket ratios*
03/07 03/08e 03/09e 03/10e
P/E (x)
8.3
6.2
5.3
5.1
P/E rel.DJ STOXX50 (%)
75.1
57.2
51.2
54.5
P/CF (x)
2.6
2.2
2.2
2.1
P/BV (x)
0.9
0.7
0.6
0.6
Net yield (%)
1.9
2.4
2.8
3.2
EV/Sales (x)
0.7
0.6
0.6
0.5
EV/EBITDA (x)
4.2
3.6
3.3
3.1
EV/EBIT (x)
10.1
8.1
6.9
6.3
* Yearly average price for FY ended 03/07
P&L highlights (EURm)
Sales
Restated EBIT
Attrib. net profit (adj.)
03/07 03/08e 03/09e 03/10e
23,077 24,110 25,403 26,813
1,570 1,787 2,082 2,278
888 1,078 1,278 1,306
Performance (%)
1w
1m
3m
12m
Absolute
Rel. Transport
Rel. DJ STOXX50
1
7
4
(12)
(1)
(6)
(17)
(14)
(16)
(26)
(26)
(24)
www.exanebnpparibas-equities.com
Stock vs Sector
Outperform
Sector vs Market
Outperform
Price (19 November 2007)
EUR22.9
Target price
EUR40.5 (+77%)
Strong globalisation play
► Network scale offers scope to exploit global growth
Air France-KLM, the world’s leading international airline, offers a strong play
on globalisation based on increased inter-connectivity between Europe and
the emerging economies. It has a unique position among the three network
airlines with: 1) a hub at Paris-CDG that has four runways and terminal
capacity that will increase significantly by the end of 2008, 2) an aircraft
acquisition programme that has already peaked and started to generate
strong FCF and 3) a flexible approach to aircraft financing that allows rapid
adaptation of capacity at no cost in the event of a downturn in demand.
► Risks of overpaying for weak airlines are overdone
Air France-KLM has the potential to lead further industry consolidation, but it
is very sensitive to the importance of value creation, in what is now largely a
buyers’ market. The recent share price weakness partly reflects investors’
concerns about the group overpaying in any possible acquisition of Alitalia or
Iberia, but we are confident that management will remain disciplined in its
2009/10e target of a post-tax ROCE of 8.5% (6.5% in 2006/07).
► Strong upside, reiterate Outperform stance
Reflecting higher fuel cost forecasts, partly offset by firmer prices and a
positive earnings impact from the Delta transatlantic JV, we have lowered
our 2008/09e and 2009/10e EPS estimates by 4% and 14%, respectively,
but remain significantly higher than the consensus. We have cut our
DCF/SOTP target price to EUR40.5 (formerly EUR46). The substantial 77%
upside to our revised target price underpins our Outperform conviction.
Price
relative to DJ STOXX50
40
35
30
25
Nick van den Brul
20
Nick van den Brul
London: +44 20 7039 9480
nick.van_den_brul@exanebnpparibas.com
15
10
2005
Air France-KLM
Relative to DJ STOXX50
2006
2007
Source: DATASTREAM
Source: Datastream
Please refer to important disclosures
at the end of this report.
Geoff van Klaveren
London: +44 20 7039 9484
geoff.vanklaveren@exanebnpparibas.com
Contents
Investment case__________________________________________ 3
Valuation upside on DCF/SOTP metrics _______________________ 8
Scale effects/cost cutting support margins ____________________ 12
Delta JV: taking advantage of Open Skies ____________________ 22
Airline acquisitions: risk/return trade-off_______________________ 28
Moving towards the 8.5% ROCE target _______________________ 37
Strong FCF leading to net debt reduction _____________________ 44
Glossary_______________________________________________ 47
Company profile and financial highlights ______________________ 50
2
Air France-KLM
Investment case
A buying opportunity following recent sell-off
We reiterate our sector-relative Outperform recommendation on Air France-KLM
shares. We have cut our target price to EUR40.5 (from EUR46) to reflect a downward
adjustment to our earnings forecasts following a reassessment of future fuel cost
trends, partly offset by firmer pricing and a positive earnings contribution from the new
transatlantic joint venture with Delta Airlines. However, our revised EUR40.5 target
price still implies an upside of 77% for the stock.
Table 1: Summary of revisions to estimates
EURm
Operating profit, previous
Fuel cost previous
Fuel cost new
Difference
Contribution from Delta JV
Net changes
Operating profit, new
Restated EPS new (EUR)
Restated EPS previous (EUR)
Change (%)
08/09e
09/10e
1,783
4,780
4,860
(80)
30
(50)
1,733
2,158
5,060
5,340
(280)
44
(236)
1,922
4.36
4.53
(4)
4.46
5.21
(14)
Note: operating profit shown here is on a reported basis
Source: Exane BNP Paribas estimates
In our view, the drivers of Air France-KLM’s margin and ROCE improvement remain
intact. Strong traffic growth, continued long-haul yield improvements and cost cutting
(including a further boost under the new ‘Challenge 10’ programme), should all support
further margin expansion and a progressive improvement in post-tax ROCE to the
group’s target of 8.5% in 2009/10e (6.5% in 2006/07).
Our 2008/09e and 2009/10e estimates are above the consensus. We believe this
reflects two factors. Firstly, we believe the investment community has not fully
recognised the positive revenue and earnings impact of the transatlantic joint venture
between Delta and Air France (and the subsequent KLM/Northwest joint venture on
routes to Heathrow, about which we still await an announcement). Secondly, we
believe the consensus is too cautious about the growth dynamics of global air traffic
and the scope for further margin improvement at Air France-KLM over at least the next
three years.
Air France-KLM trades on only 3.3x calendarised 2008e EV/EBITDAR and 7.0x EV/EBIT,
compared to the European network airlines’ current averages of 4.9x and 10.7x,
respectively, and against an average EV/EBITDAR multiple of around 4.6x at the time of
the last trough in the cycle in 2003 (which was a severe downturn, involving both the
second Gulf war and the spread of the SARS disease).
Our Outperform recommendation on Air France-KLM reflects its exposure to the longterm growth dynamics of air travel and its particularly strong position in serving
emerging economies. This is combined with the limited long-haul capacity growth
profile of the industry through to 2010, which will keep yields firm.
We believe one of the catalysts for the shares is likely to be the Q2 2007/08 results on
22 November which should confirm these positive factors. In addition, improved
visibility on the earnings potential of the Delta joint venture is also likely to provide
support for the shares.
3
Air France-KLM
Share price performance
In 2006 and H1 07, Air France-KLM outperformed the CAC 40 index by 28.4% and
strongly outperformed its benchmark competitors, Lufthansa and British Airways (BA).
The main reason for this was Air France-KLM’s significant improvement in earnings and
the trend towards higher margins that followed the merger (April 2004) between Air
France and KLM, as efficient reorganisation of route networks and greater economies
of scale led to improved asset utilisation.
In August 2007, Air France-KLM fell by over 30% in absolute terms and
underperformed the CAC 40 index by 7.6%. Despite a recent recovery, the share price
remains 72% below its June peak of EUR39.4.
In our view, the current share price assumes a collapse of passenger revenue growth
and operating profit in 2008/2009. We have undertaken a worst case sensitivity
analysis which assumes that growth in the passenger business falls to 0.4% and costs
remain static in that year. As a result, operating profit for 2008/09 would more than
halve from an estimated EUR1,733m to EUR727m, representing a 2.98% margin. Air
France-KLM believes that with its new operating structure and cost profile, 3% would
be the worst-case margin at the bottom of the cycle. Our DCF valuation using this
scenario would give a valuation per share of EUR23.91, implying 4% upside to the
current share price.
We have identified three reasons for the stock’s relative underperformance after the
period of strong outperformance: 1) a perception from the Q1 2007/08 results (for the
three months to end-June 2007) that the trend of margin improvement had stalled, 2)
concerns that the turbulence in financial markets could herald a downturn in air traffic
markets, and 3) speculation that the pending round of further airline consolidation in
Europe (involving Alitalia, Iberia, Austrian Airlines, bmi and possibly SAS) could lead to
Air France-KLM overpaying for second-tier airline assets in order to gain market share.
We believe all these concerns are misconceived.
Margin trend remains positive
The group’s Q1 2007/08 results (announced 9 August) contained two major negative
factors; a one-off adverse impact on business class travel reflecting the timing of public
holidays in France and a negative impact from the US dollar’s decline against the euro,
which had an adverse effect on intercontinental yields (but a positive effect on costs).
However, Air France-KLM confirmed its strong current performance in terms of traffic
and yield at the Investor Day at Paris-CDG airport in October. The aberration of Q1
(which was impacted negatively by holidays) has not continued into Q2 and since July,
cargo has been on a recovery trend.
The Q2 2007/08 results (to be announced on 22 November) are likely to benefit from
the new cost-cutting programme, “Challenge 10”. This had a minimal impact on the
Q1 2007/08 results because it had only been launched in May. Recent comments from
management suggest that this Challenge 10 programme is likely to have had a positive
impact on Q2 2007/08 results.
4
Air France-KLM
Around EUR130m of the EUR560m of targeted cost savings from the new Challenge
10 cost-savings programme for 2007/08 have been achieved. These EUR560m cost
savings include EUR35m from marketing costs, EUR150m from purchasing costs,
EUR200m in processes and productivity and EUR175m from the fleet modernisation.
This programme is expected to achieve total savings of EUR1.4bn over three years.
Furthermore, management confirmed that the 7% post-tax ROCE target (implying a 0.9
percentage point increase in the EBIT margin to 7.4% in 2007/08e) should be easily
achieved. The implication is a small increase in our full year 2007/08 estimates, but this
is neutralised by the estimated EUR60m EBIT cost of the cabin crew strike at the end
of October. Consequently, we leave our 2007/08 EPS forecasts unchanged.
We are confident that the rising trend of EBIT margins should continue in at least
2007/08e, 2008/09e and 2009/10e.
Air traffic still growing, boosted by emerging economies
In our view, Air France-KLM remains one of the best European plays on globalisation, as
the leading connector of Europe to the growth economies in Asia, Latin America, Middle
East/Africa and Eastern Europe. Our analysis shows that, while US–Europe and
domestic US traffic have clearly started to slow, traffic to and from the emerging
economies remains very robust. Air France-KLM, as the world’s largest international
airline, looks particularly well placed to benefit from the continued growth of the global
economy.
Air France-KLM is a well-managed airline with an increasing long-haul orientation and
has moved from the number three position in Europe to the clear market leader in both
Europe and the international airline business within the space of three years. Much of
the reason for this lies in the scale and continuous improvements in the structure of the
group’s hub and spoke network.
Air France-KLM has the greatest exposure of all European airlines to the world's growth
economies in Asia, Latin America and Middle East/Africa. (These three regions
accounted for 48% of passenger revenues in 2006/07). Furthermore, new capacity
growth in the next five years is concentrated in these areas so this percentage will
increase. The group, therefore, enjoys a growth dynamic which, in our view, will
continue to perform strongly despite an anticipated slowdown in the US and European
economies. (By contrast, BA is heavily exposed to UK–US traffic which accounts for
around 65% of its operating profit. The US domestic air travel market has started to
weaken and US airlines are suffering more from higher oil prices as they do not gain
from the sharp fall in the US dollar this year. In contrast, the fall in the US dollar is
helping to contain fuel, depreciation and other costs of European airlines).
We believe the new joint venture agreement with Delta and closer ties with China
Southern also offer good long-term growth opportunities for the group and that these
have possibly not been fully recognised by the investment community.
5
Air France-KLM
Strict ROCE criteria in any acquisition scenario
In our view, industry consolidation will accelerate as Open Skies between Europe and
the US starts to put pressure on protected “national” niche operations (for example,
Milan–New York), eroding the profitability of those routes. Therefore, we believe the
industry is in a process of voluntary consolidation for those smaller airlines which will
need to seek the protection of economies of scale, the support of an efficient fuel
hedging programme, access to capital for investment and participation in the large
corporate account programmes which drive network airlines’ profitability. Air FranceKLM should benefit significantly from this consolidation process.
Iberia and Alitalia have put themselves up, or been put up, for sale now for almost a year.
However, Air France-KLM and Lufthansa, the two most obvious acquirers, have sensibly
waited for potentially improved acquisition terms. The conditions have improved and the
“speculative” appetite from private equity funds has probably diminished as highly leveraged
bids appear less likely in the current market climate. In these circumstances, we believe Air
France-KLM is much less likely to overpay for vulnerable operating airline assets, especially
as the experience of acquiring KLM (and also Swiss) shows that the balance of advantages
in terms of scale and strength of balance sheet is with the acquirer.
The benefits of consolidation are closely linked to improvements in operations, which
have a direct impact on asset utilisation and thus on earnings and margins. Linking hub
and spoke networks allows airlines to concentrate routes, allowing larger, more efficient
aircraft and more frequent services. As occurred following the merger with KLM, the
addition of a new spoke to a hub and spoke airline network significantly increases the
city-pair combinations served by the network, at minimal additional cost. Thus, while
small-scale, standalone airline operations can be unprofitable (such as Alitalia) within the
framework of linked hub and spoke networks, they can turn round their fortunes relatively
quickly if the network is reconstructed and linked effectively and overlapping costs are
eliminated quickly.
Air France-KLM has commented that it is "interested in" Iberia and Alitalia, but as yet
there do not appear to be any concrete negotiations. Indeed, it seems more likely that
Iberia will be acquired by a Spanish investor group. Furthermore, Air France-KLM’s
President and CEO, J-C Spinetta, has consistently stated that no deal would be done
with either Alitalia or Iberia which could jeopardise the group’s achievement of its
2009/2010 post-tax ROCE target of 8.5%.
EPS forecasts trimmed reflecting oil price
We have revised our 2008/09e and 2009/10e EPS estimates downwards by 4% and
14%, respectively, to reflect, in part, the group’s revised oil price forecasts. The
negative impact of these higher oil price assumptions is partly offset by firmer prices
(see below). The new estimates assume structurally higher oil prices because of tight
capacity, higher extraction costs and (implicitly) sustained global demand. Our
forecasts are based on the group’s assumptions of an average Brent oil price of
USD81/bbl for 2007/08, USD88/bbl for 2008/09 and USD84/bbl for 2009/2010.
The group is 78% hedged against the fuel price this year, giving a net price of
USD66/bbl, and is 67% hedged next year (2008/09e), giving a USD69/bbl final price.
Incorporating the group’s revised estimates and the impact of the fuel cost hedge, we
keep our estimate of hedged fuel costs for Air France-KLM for the current year at
EUR4.6bn, but increase our estimates for 2008/09 to EUR4.86bn (+1.7%), for 2009/10
to EUR5.34bn (+5.5%) and for 2010/11 to EUR5.62bn (+7.5%).
6
Air France-KLM
Price component of yield remains firm
Air France-KLM has managed to compensate for fuel price increases with a
progressive increase in fuel surcharges on tickets, which reached EUR72 on a longhaul flight for Air France and EUR70 for KLM in early November (following an earlier
increase in September). This is because capacity constraints and rising load factors on
long-haul routes have given the leading long-haul airlines pricing power which is partly
compensating for the sharp rises in oil prices. While there has been a strong increase
in short-haul, low-cost capacity this year, capacity remains constrained on long-haul
routes. We do not see this easing until 2009 at the earliest.
Yields should continue to be supported by further consolidation (Alitalia, Iberia and
closer relationships between members of the three international airline alliances,
SkyTeam, Star and oneworld). Air France-KLM’s passenger traffic has been growing at
over 5% this year to date, focused on growth areas in the global economy. Capacity is
scheduled to increase by 5.2% for the winter season (October–March) and this is
focused on destinations in high-growth emerging economies (China, Latin America,
Middle East/Africa and Eastern Europe). Additional frequencies to Shanghai and Hong
Kong alone will increase capacity on those specific routes by 20% in anticipation of
strongly rising demand.
Delta joint venture to boost earnings from 2008/09e
Partly offsetting the impact of the higher fuel price, the group’s transatlantic joint
venture with Delta, announced in October, will provide a further boost to earnings. We
estimate that the Delta joint venture (which is entirely incremental to earnings for Air
France-KLM until 2010/11, when the joint venture’s parameter will be expanded to
include existing routes) will add EUR31m to operating earnings in 2008/09 and
EUR44m for 2009/10. This has a positive effect on our EPS estimates of EUR0.10 for
2008/09e and EUR0.15 for 2009/10e.
The net effect, taking into consideration a higher fuel cost and a positive contribution
from the joint venture, is that our EPS estimates decline by 4% to EUR4.36 for
2008/09e and by 14% to EUR4.46 for 2009/10e. Consolidation and closer cooperation
within alliances has a positive net effect that partly compensates for higher oil prices,
the remaining unmanageable variables being the movement of the US dollar (a US
dollar decline is positive for Air France-KLM’s costs, although it would have a negative
impact on the joint venture‘s contribution) and the group’s ability to increase fuel
surcharges (mainly long-haul passenger airline prices) further. We consider our
estimates for the potential benefits of the Delta joint venture, which is the only
quantifiable effect of the proposed joint venture initiatives at present as very
conservative and see room for upgrades.
7
Air France-KLM
Valuation upside on DCF/SOTP metrics
Our approach to the value of Air France-KLM is to look at comparative and sum-of-theparts metrics around a core DCF valuation. The DCF method captures both the airline’s
cash flow generation and capital expenditure on replacement fleet assets. Based on an
average of our DCF and SOTP approaches, we calculate an equity value for Air
France-KLM of EUR12,158m, corresponding to EUR40.5 per share. Our DCF
approach produces a value of EUR42.1 per share and our sum-of-the-parts model
produces a range of EUR38–40 per share with an average of EUR39. Our revised
target price of EUR40.5 is based on the average of the DCF and SOTP outcomes.
Air France-KLM’s valuation discount to BA of 27% on calendarised 2008e
EV/EBITDAR multiples at current price levels looks unjustified. Air France-KLM’s
earnings growth outlook is strongly positive and better than BA’s, with a positive
earnings increment from Open Skies (not included in the current guidance) but without
the significant risks posed by the sudden impact of new competition for BA at
Heathrow, for example.
We are confident in the ability of Air France-KLM’s management to deliver increased
earnings growth and higher margins from the implementation of the Challenge 10 costcutting programme and the realisation of further synergies from the merger, notably
through the introduction of common IT systems. Our valuation takes into account a
raised fuel cost assumption (detailed below) and rolls forward our DCF valuation to the
end of 2008.
DCF model: EUR42.1 per share
Our DCF valuation is based on our assessment of the network and cost synergies still to
be extracted from the merger, along with the ongoing boost to forecast earnings from the
Challenge 10 cost-savings programme under way and the positive impact of the Delta
joint venture, set against a higher medium-term fuel cost forecast of approximately
USD81/bbl Brent equivalent. We set out our key assumptions as follows.
Traffic and yields
Our passenger traffic growth assumptions are 6% for 2007/08 and 5% for 2008/09.
The main driver is likely to be intercontinental traffic, continuing the trend of recent
months. We assume a (post-currency effect) trend in yields (in terms of revenue per
RPK) of -0.5% this year, +0.2% for 2008/09eand approximately +0.5% p.a.
thereafter.
Oil price and fuel costs
We have used higher oil price assumptions as the basis for our post-hedge fuel price
estimates for Air France-KLM. Our Oil & Gas team’s current oil price estimates (revised
in early October 2007) assume structurally higher oil prices because of tight capacity,
higher extraction costs and (implicitly) sustained global demand. Our actual fuel cost
estimates are based on the Air France-KLM group’s latest assumptions of an average
Brent oil price of USD81/bbl for 2007/08, USD88/bbl for 2008/09, USD84/bbl for
2009/10 and USD82/bbl for 2010/11. Using these revised assumptions, we keep our
estimate of hedged fuel costs for the current year at EUR4.6bn but increase our
estimates for 2008/09 to EUR4.86bn (+1.7%), for 2009/10 to EUR5.34bn (+5.5%) and
for 2010/11 to EUR5.62bn (+7.5%).
8
Air France-KLM
WACC
We calculate a WACC of 7.49% (raised from 7.04%). This is based on an equity risk
premium of 4.49% (from 3.83%), a risk-free rate of 4.16% (from 4%), a pre-tax cost of
debt of 5.16% and a beta of 1.4. Our long-term growth assumption is 1%.
DCF outcome
Our revised DCF equity value for Air France-KLM comes to EUR42.1 per share. As
noted, we set our new target price at the average of this and our average SOTP value
of EUR39 per share. We summarise our revised DCF valuation in the table below.
Table 2: Air France-KLM – DCF valuation and assumptions
Component
Output
Values (EURm)
PV of 07/08e–16/17e
Terminal value
EV
Net debt end 2007/08e
Revalued minority interests
10,047.4
10,361.6
20,409.0
(8,104.0)
(66.4)
Revalued investments
Equity value
Shares (m)
Equity value per share (EUR)
Rates (%)
RFR
Risk premium
Long-term growth
Pre-tax cost of debt
Tax rate
Post-tax cost of debt
Forecast % of debt
Beta (x)
Cost of equity
WACC
398.0
12,636.6
300
42.09
4.16
4.49
1.00
5.16
25
3.87
45
1.40
10.4
7.49
Source: Exane BNP Paribas estimates
Sum-of-the-parts approach: EUR39 per share
While Air France-KLM’s earnings are built mainly on the passenger business, we believe
the group’s business mix still lends itself to a sum-of-the-parts valuation. We value the
core business segments based on multiples of forecast EBIT (adjusted for operating
leases), as shown in the following table.
Table 3: Air France-KLM – sum-of-the-parts valuation
EURm
Passenger
Cargo
Maintenance
Catering
Transavia/Leisure
Total
Equity affiliates (BV)
WAM/Amadeus/Opodo
Adjusted operating income
06/07
07/08e
08/09e
1,067
62
44
16
35
Net debt (including
capitalised leases)
Minorities
Equity value
Value per share (EUR)
Avg. value per share (EUR)
Source: Exane BNP Paribas estimates
9
Air France-KLM
1,490
58
49
18
42
1,726
62
52
22
55
Multiple (x)
07/08e
08/09e
12
9
9
9
9
10
8
8
8
8
Estimated value
07/08e
08/09e
17,880
522
441
162
378
19,383
17,260
496
416
176
440
18,788
198
200
198
200
(8,104)
(8,104)
(66)
11,611
40
(66)
11,016
38
39
Our multiples of 12x (2007/08e) and 10x (2008/09e) operating income applied to Air
France-KLM’s largest business segment, the passenger activity, are equivalent to the
network airlines’ average. This could be considered conservative given our higher profit
growth expectations for Air France-KLM.
Our model indicates an estimated EV for Air France-KLM of EUR19.38bn for
2007/08e.and EUR18.79bn for 2008/09e. After deducting net debt and minorities, we
arrive at an equity value range of EUR11.6bn to EUR11bn, averaging out at
EUR11.3bn and corresponding to EUR39 per share. This is close to our DCF valuation
and 70% above Air France-KLM’s current share price, supporting our view that the
shares are significantly undervalued.
Comparative trading multiples support the upside
Our comparative analysis shows that Air France-KLM still looks inexpensive relative to
its peers at current share prices. The market continues to apply a discount to Air
France-KLM (in particular compared to BA) because of the perceived merger risks.
Air France-KLM shares trade on a calendarised 2008e EV/EBITDAR multiple of 3.3x,
compared to 4.5x for BA and 3.4x for Lufthansa.
The group currently uses operating leases to finance around one third of its fleet
because of the flexibility that this introduces, i.e. the ability to reduce fleet capacity
without incurring penalties. We consider capitalising operating lease payments at 7x to
be conservative, as it inflates the multiple relative to competitors, which use mainly
bank debt and retain the residual value of the asset. In terms of EV/CE, Air FranceKLM’s calendarised 2008e multiple of 0.9x is the same as Lufthansa’s of 0.9x but
substantially below BA’s (1.1x). Based on our estimates for price/cash flow, Air FranceKLM trades on a calendarised 2008e multiple of 2.2x, compared to 4.3x for BA and
3.8x for Lufthansa.
Table 4: European Transport universe – valuation multiples
EV/EBITDAR
08e
09e 08e TP
EV/EBIT
(adj for leases)
FCF yield (%)
08e
09e 08e TP 08e
09e
08e
P/E
09e
08e TP
EV/CE
08e
09e
ROCE ex gw (%)
08e
09e
Network airlines
Air Berlin
Air France-KLM
Austrian Airlines
British Airways (GBP)
Iberia
Lufthansa
Average
7.2
5.5
5.2
8.1
16.3
6.8
8.2
5.9
5.5
5.1
9.6
16.5
5.4
8.0
7.9
9.7
11.2
12.1
14.3
11.8
11.3
7.4
3.3
3.9
4.5
6.7
3.4
4.9
6.5
3.0
3.8
3.9
6.6
2.8
4.4
7.6
4.6
5.0
5.1
6.2
5.2
5.7
15.0
7.0
10.2
11.0
15.1
6.1
10.7
12.4
5.8
10.2
8.6
15.0
5.0
9.5
15.3
9.8
13.2
12.7
14.1
9.3
12.5
13
12
42
11
5
6
14.9
7
9
(5)
8
4
6
4.9
1.0
0.9
0.8
1.1
1.8
0.9
1.1
0.9
0.9
0.8
1.0
1.9
0.8
1.0
5.1
8.9
5.7
6.4
8.5
12.6
8
6.0
9.2
5.5
7.2
8.2
14.0
8.5
Low-cost airlines
easyJet (GBP)
Ryanair
Average
13.0
14.1
13.5
7.6
11.5
9.5
20.1
15.2
17.6
6.8
8.2
7.5
5.5
6.6
6.1
10.8
8.9
9.8
9.6
11.6
10.6
7.5
9.1
8.3
16.3
12.5
14.4
(3)
0
(1.5)
(3)
5
0.8
1.6
2.3
2.0
1.5
2.0
1.8
13.8
18.0
16
15.1
19.7
17
Airports
ADP
Fraport
SAVE
Average
28.2
23.8
16.9
23.0
0.0
0.0
0.0
0.0
35.7
23.9
17.7
25.8
11.7
9.2
7.8
9.6
10.5
8.9
6.2
8.5
14.1
9.2
8.1
10.5
19.1
18.1
10.0
15.7
17.3
17.7
7.5
14.2
23.1
18.1
10.4
17.2
2
(9)
5
(0.8)
2
(8)
7
0.5
1.7
1.6
1.7
1.7
1.7
1.5
1.6
1.6
6.1
7.2
14.9
9
6.5
6.4
10.8
8
Shipping & Logistics
A.P Moller-Maersk
Deutsche Post
Average
10.7
9.0
9.8
8.9
0.0
4.4
12.9
11.7
12.3
4.4
4.7
4.5
3.9
4.3
4.1
5.3
6.2
5.7
6.4
6.6
6.5
5.5
6.1
5.8
7.6
8.8
8.2
0.9
8.3
4.6
5.3
7.1
6.2
1.2
1.6
1.4
1.1
1.5
1.3
12.7
39
26
13.4
40
27
Note: data are based on closing share prices of 19 November 2007; data for Air France-KLM, British Airways, easyJet and Ryanair are calendarised
Source: Exane BNP Paribas estimates
10 Air France-KLM
At 12% for 2008e and 9% for 2009e (both calendarised), Air France-KLM’s projected
FCF yield is higher than those of BA and Lufthansa, largely because Air France-KLM
already generates strong cash flow, reflecting in part its decision to renew the long-haul
fleet earlier than its main rivals.
We believe the discount applied to Air France-KLM is unjustified, as we see
considerably fewer operational risks for Air France-KLM than for BA. This is particularly
the case because of the vulnerability of the latter’s North Atlantic yields to an Open
Skies agreement and its free cash flow erosion following the sharply increased capex
requirements in connection with the long-haul fleet renewal from 2009.
Our adjusted EBIT margin forecasts have changed in accordance with our revised fuel
cost assumptions but synergy upgrades, and in particular the contribution from the new
joint ventures, should provide scope to increase them in the future.
Valuation risks
The main risk to our valuation scenario for Air France-KLM relates to the possibility of a
downturn in traffic based on a fall-off in demand. However, the consensus remains in
favour of a positive outlook for global growth in airline traffic volumes and for Air
France-KLM in particular, based on sustained growth of the emerging economies.
There is also the threat of a much higher level of jet fuel prices, and as noted we have
raised our cost estimates for 2008/09 and onwards to take account of this. However,
these are chiefly short/medium-term earnings risks that apply to all airlines. As noted,
Air France-KLM has a highly protective hedge in place through 2007/08 and lower, but
still significant, levels of hedging that are higher than those of competitors for 2008/09
and 2009/10. Our emphasis is on the medium-term opportunities for cash flow
enhancement through the greater market presence and higher asset utilisation
achieved through the merger, as well as the opportunities to cut costs. We believe the
fuel price risk is factored into the shares’ current valuation and the valuation discount
has been overstated. As discussed in the section, “Airline acquisitions: risk/return
trade-off”, later in this report, we believe the possibility of a loss of value as a
consequence of overpaying for second-tier airlines is minimal, given management’s
track record and continuing cautious approach to acquisitions.
11 Air France-KLM
Scale effects/cost cutting support margins
The logic behind the Air France-KLM merger in 2004 was to increase revenues through a
widening of the marketing reach (economies of scope) and to reduce joint costs and
improve aircraft utilisation through process reorganisation and integration (economies of
scale). In our view, both factors are already resulting in, and continue to underpin,
progressive improvements in asset utilisation and thus in margins and ROCE. Air FranceKLM brought forward its 7% post-tax ROCE target by two years to the current year and
raised its 2009/10 target by 1.5% to 8.5%. In our view, this implies that Air France-KLM is
confident of achieving a 2009/10 EBIT margin adjusted for leases of at least 8%.
In this section, we examine two areas where margin has or could grow, based on
increased scale effects. The first is an analysis of the scale effects which have built
margin expansion since the merger between Air France and KLM and which create the
platform for further growth. The second, more speculative, but nonetheless, real analysis
is an attempt to quantify the potential earnings enhancement that could be created
through an acquisition of either Alitalia or Iberia, as well as the potential benefits from the
establishment of transatlantic joint venture operations between Air France-KLM and their
US SkyTeam alliance partners, Delta and Northwest Airlines.
Earnings driven by the global network
The group’s main revenue drivers are the larger network/schedule choice available to
customers through the densification of international services from the two European hubs
(Paris and Amsterdam) and fusion of pricing and distribution channels of the two airlines,
combined with code-share links to the global SkyTeam alliance network. The
improvement in profits and margins is coming from both higher revenues and savings in
costs. Our SWOT analysis shown below indicates that Air France-KLM has significant
advantages over its main competitors, especially the growing focus on long-haul services
to emerging economies and the significant increase in scale and the development of the
twin hub and spoke system, which benefits from an unconstrained airport asset base.
Table 5: Air France-KLM – SWOT analysis
Strengths
Weaknesses
!
Leading European/global airline group with
significant economies of scale.
!
High capex but lower than competitors going
forward
!
Enhanced European catchment area
!
Need to promote further a ‘competitive’ culture
!
Twin hub focus reinforcing pricing/marketing power
!
Financial leverage (but declining)
!
Efficient new fleet
!
“Complexity” cost cutting needs to be ongoing
!
Growing proportion of long-haul flights
!
Greater proportion of “unique” destinations from
Europe
!
Capitalise on central dual hub-based network
!
!
Capture European sourced international traffic
Short-haul pricing pressure as competition
intensifies
!
Use SkyTeam alliance to strengthen margins
!
Persistently high fuel costs
!
Improve labour relations via employee ownership
programme
!
Personnel cost increases despite long-term
agreements in place
!
Generate cost cuts to raise margins
!
Collapse or weakness of partner airlines
Opportunities
Source: Exane BNP Paribas
12 Air France-KLM
Threats
New management structure in place
Earlier this year, Air France-KLM introduced a new combined executive management
structure on a functional basis, replacing the separate management structures in Air
France and KLM. In place of the Strategic Management Committee, which had
supervised the development of Air France and KLM over 2004–2007, the business is
being managed from 2007 through an Executive Committee whose members have a
group level responsibility and can come from either Air France or KLM while retaining
their responsibilities at a company level. This should facilitate the introduction of the
process and productivity improvements which are part of the “Challenge 10” cost-savings
programme, discussed in the later section, “Moving towards the 8.5% ROCE target”.
Global network is a platform for growth
Since the merger, there has been consistently strong growth on routes to the Americas
(North and South America) and to the Asia-Pacific region. These growth rates outstrip
other carriers. BA no longer provides comparable information (disclosure is by origin of
sale which has less information value) but passenger traffic (in RPKs) was only 0.5%
higher on routes to the Americas and actually fell by 4% on routes to Asia in 2006/07. It
is therefore clear that Air France-KLM is substantially outperforming its competitors on
those routes. This is confirmed by the Association of European Airlines’ (AEA) market
share data, which shows Air France-KLM raising its market share among the AEA
(excluding low-cost carriers) from 26.2% to 27.1% over the period May 2004–
December 2006, whereas BA’s market share declined from 16.9% to 16% and
Lufthansa’s (including Swiss) fell from 20.2% to 18.9%.
Chart 1: Air France-KLM – scheduled passenger revenues, 2006/07
Africa/Middle East
14%
France
13%
Caribbean/Indian
Ocean
7%
Asia
15%
North America
16%
Latin America
7%
Europe/North Africa
28%
Source Company, Exane BNP Paribas
Air France-KLM’s growth strategy is consistent with the emphasis on balanced, profitable
growth which does not rely on one dominant geographic area (and therefore also not on
one particular economy) and focuses as much on the development of the KLM brand as it
does on that of Air France. The group’s long-haul offering in 2006/07 consisted of 118
destinations in 69 countries, including 35 destinations operated by KLM and 47 operated
by Air France. Traffic for one third of the combined group’s destinations is sufficiently
high-volume for them to be served by both Air France and KLM, each of which are served
by different Continental European catchment areas. In 2006/07, long-haul traffic
increased by 5.2% and revenues generated on long-haul networks rose by 11.4% to
EUR10.26bn, representing 59% of scheduled passenger revenues.
13 Air France-KLM
KLM appears to be participating equally in long-haul growth. This has been the
consistent trend since the merger took place, showing the predicted benefits to KLM of
access to Air France’s much larger network and customer base. Both operating
companies have started to see a greater correlation of their business with the global
economy rather than with their home markets, as evidenced by recent traffic figures. Air
France-KLM is successfully expanding its premium passenger base from destination
countries and through connecting passengers, as reflected in the results (2006/07
showed a 17% increase in the premium transfer passenger yield, the RASK, excluding
currency effects) on long-haul traffic compared to a rise in the economy class yield of
only 6%). Around 40% of passengers on Asian routes originate in Asia.
The merged Air France-KLM group is now playing to its strength, which is the increasing
power of its combined schedules and common ticketing system to attract long-haul
business and leisure passengers (hence load factors that are significantly higher than at
either BA or Lufthansa). This is not a weak position which relies too heavily on lower-yield
transfer passengers. In our view, it is more important to fill the aircraft with a mix of
connecting and point-to-point high yield passengers as this maximises revenues and
asset utilisation while spreading the traffic risks. Whereas BA’s earnings look vulnerable
to traffic or yield erosion on North Atlantic traffic, Air France-KLM has a more robust
spread of business (with, for example, the strongest European carrier position in Japan
which is now showing good growth, along with leading positions in all long-haul markets).
Long-haul passenger demand remains strong, exceeding supply, and supporting yields
and load factors. Despite some aberrations in May traffic figures because of the
number of holidays (traffic was nevertheless 3.9% higher in that month with the load
factor flat, compared to a 2.1% traffic decline and a 1.5 point fall in the load factor for
BA) long-haul demand remains strong for Air France-KLM, powered by the hub
synchronisation effect (linked schedules) between Paris and Amsterdam which is
driving Air France-KLM's growth, both in absolute terms and in terms of market share.
Overall long-haul capacity grew at 5.6% this summer, with the leading European
carriers increasing capacity by 6% and capacity from non-European competitors
increasing by 4%. KLM’s transatlantic capacity is increasing at a higher rate because
Northwest is raising capacity more than the average and KLM is seeking to rebalance
its contribution to the existing transatlantic joint venture. Such strategic changes in
capacity are likely to be seen increasingly after Open Skies in March 2008 following the
joint venture with Delta, especially if Air France-KLM is successful in achieving the fourparty anti-trust immunity for Air France, KLM, Delta and Northwest, for which an
application to the US Department of Justice has been made.
The synchronised hub strategy works
This progressive construction of the twin hub system in Paris and Amsterdam, both of
which are relatively unconstrained in terms of infrastructure capacity compared to
Heathrow and Frankfurt, is paying off. Between May 2004 and December 2006, Air
France-KLM increased its market share (AEA traffic) from 26.2% to 27.1% and now has
critical mass in most of its main markets. In contrast, BA and Lufthansa have both lost
market share.
14 Air France-KLM
Chart 2: Medium-haul, long-haul connections under two hours (summer 2007)
25,000
20,695
MH-LH connections
20,000
15,000
13,020
10,000
7,193
5,000
7,070
3,097
4,110
0
Paris-CDG
Amsterdam
Zurich
Munich
Frankfurt
LondonHeathrow
Source: Exane BNP Paribas estimates
This is because Air Fance-KLM offers more destinations and route combinations
through its twin hubs. This is attractive for the large corporate accounts. BA's
alternative strategy of focusing on point-to-point premium business from Heathrow
produces high yields on dense long-haul routes but is highly vulnerable to new
competition, such as the business class only airlines, Eos and Maxjet, and after
March 2008 from new services by the large US airlines which are currently excluded
from the rich Heathrow–US market (9 out of the 12 most profitable routes from Europe
to the US are from Heathrow).
Network improvements drive gains
Network improvements and increasing coordination of sales and revenue management
activities have contributed to sustainable improvements in the group’s market position,
especially with global corporate accounts. This is expected to be given a further boost
in 2008–2010 from the introduction of a common sales and marketing IT backbone (the
Amadeus Altea system) which is also expected to lead to increased on-line sales and
e-ticketing. This leads to a virtuous circle in terms of customer capture and retention,
along with lower sales and distribution costs.
In 2006/07, traffic in Asia traffic (RPKs) was 9.9% higher, while capacity grew by 7.9%.
The seat load factor rose by 1.5 points to 86.8%. In Latin America, growth was even
stronger; traffic was 11.2% higher while capacity increased by 6.6% and the yield (RASK)
was up 22%. Routes to Middle East/Africa saw traffic grow by 6.8%, 0.8 points higher
than the growth in capacity. Even in Europe, there was a difference between growth in
traffic at 6.3% and capacity at 5.2%. Traffic grew by over 6% yoy over June–August.
Statistics for September showed traffic growth of 5.3% and seat load factors broadly
stable at high levels with the exception of the Americas, where a capacity increase of
12.3% yoy and traffic growth of 9.2% saw a 2.4 point fall in the seat load factor.
The October traffic figures showed underlying growth of 4.5% yoy and a seat load factor
maintained at the high level of 80.6%, although the reported figures showed a decline of
0.7% because of the impact of the strike (which mainly affected European traffic).
15 Air France-KLM
Chart 3: Air France-KLM and BA – monthly traffic growth, yoy
10
100
8
90
RPK growth (%)
70
4
60
2
50
0
40
30
(2)
Load factor (%)
80
6
20
(4)
10
(6)
0
Oct-06
Dec-06
Feb-07
Apr-07
Jun-07
Aug-07
Oct-07
Air France-KLM traffic growth
BA traffic growth
AF-KLM load factor (rhs)
BA load factor (rhs)
Source: Exane BNP Paribas from company statistics
The reasons for this are: 1) Air France-KLM’s management realised early on that airline
consolidation was both possible and desirable, despite the risks, 2) the merger of Air
France with KLM was carefully planned and executed, leading to clear success over a
three-year period; and 3) the group pioneered the model of separate brands but closely
coordinated activities based around synchronised hub and spoke systems which
delivered economies of scale and improved asset utilisation. In addition, considerable
focus was given to the development of networks in high traffic growth regions, such as
Asia-Pacific and Latin America, and this continues to bear fruit in terms of growth and
load factor improvements. The infrastructure for this development continues to improve,
both at Paris-CDG airport and at Amsterdam-Schiphol, most recently with the opening
of satellite S3 at Paris-CDG in June 2007.
Strongly positioned in Asia
Capacity (and traffic) have been growing over-proportionately on Europe–Asia routes and
this is expected to continue for the next decade. Air France was traditionally the leading
European carrier to Japan and this position has been consolidated, while KLM brings a
strong network to South-East Asia (Jakarta was one of KLM’s first international routes).
Air France-KLM had the leading capacity share (and high seat load factors) on EuropeAsia routes in summer 2007 at 12.9% compared to 11% in summer 2006. This route area
is targeted for the highest growth.
Table 6: Capacity shares on routes to Europe–Asia, summer 2007
Airline
Air France-KLM
Lufthansa-Swiss
British Airways
Thai Airways
Singapore Airlines
Cathay Pacific
JAL
Capacity share (%)
12.9
11.0
7.7
7.0
6.4
4.7
4.4
Source: Company data, Exane BNP Paribas estimates
There has been a notable change in the customer profile on Europe-Asia routes in the
past five years, with around 40% of passengers now originating in Asia. This is
convincing evidence of the increasing globalisation of the leading international airlines,
especially Air France-KLM.
16 Air France-KLM
El Dorado in Latin America
Air France-KLM’s strong expansion in Latin America following the merger appears to
have been a successful strategic move, as the Latin American economies grew strongly
and demand for airline services rose strongly, but financial difficulties at national airlines,
such as Varig, meant that supply was restricted.
Middle East/Africa also showing good growth
Development of the African market has likewise been a success for Air France-KLM, as
Air France’s dominant presence in French speaking West African markets was
complemented by KLM’s presence in Eastern and Southern Africa. KLM’s route network
to the Middle East also boosted the group’s presence considerably in this fast-growing
region.
Premium transfer growing at fastest pace
The fastest growing passenger group has been premium transfer passengers, as the
strength of the long-haul schedules has attracted new passengers to the network.
Air France-KLM’s short-haul passenger markets have faced strong competition from
new entrants and management’s response has been to cut in-cabin costs, reduce
capacity and to refocus capacity on the connecting network. There were already
significant adjustments of capacity in response to the opening of the TGV route to
Marseilles, Strasbourg and in the medium term Air France-KLM will itself be seeking
(from the customer retention perspective) to participate in the rail market in France,
possibly with a competitor to SNCF, such as Veolia, in order to ensure an efficient
connection service to medium/long-haul airline flights (unlike in the US, intermodality of
passenger transport systems is likely to be an important development in Europe).
Ryanair has started services from Marseilles to European destinations but has already
had to withdraw three routes (Marseilles to Bremen, Baden-Baden and Rome) for lack
of traffic. By contrast, Transavia, France, the leisure specialist airline which operates as
a joint venture between KLM’s subsidiary, Transavia, and Air France, has started well
out of Paris to the first leisure destinations of Porto, Monastir and Djerba.
Chart 4: Air France-KLM’s network shows strong ability to attract premium
transfer passengers
18.0%
16%
16.0%
Percentage growth
14.0%
12.0%
11%
10%
10.0%
8.0%
6%
6.0%
4.0%
2.0%
0.0%
Passengers
Revenues
Source: Company, Exane BNP Paribas, data for FY06/07
17 Air France-KLM
Transfer revenues
Premium transfer
revenues
Growth in airport infrastructure will improve efficiency
Of all the network airlines, Air France and KLM enjoy the best hub airport infrastructure.
Heathrow will have additional terminal capacity following the commissioning of
Terminal 5 from March 2008 but is constrained by only having two runways. Frankfurt,
Lufthansa’s main hub, similarly has adequate terminal capacity, which is being
extended but only two parallel runways and a cross runway. If it is not delayed further,
the earliest date for a new runway at Frankfurt is 2011. There are no runway constraints
at Paris-CDG, which has four runways arranged in twin parallel systems, and
Amsterdam-Schiphol, which operates five runways.
Next year, Air France will gain considerably from the expansion of infrastructure capacity
at Paris-CDG airport, with incremental capacity for 19.4m passengers and a large number
of additional contact stands by the end of 2008. The first phase of this expansion, a
spacious new boarding terminal, Satellite S3, with capacity for 7m passengers, was
opened in June 2007.
Paris-CDG airport’s four parallel runways are sufficient for at least 120m passengers, or a
doubling of current capacity. Satellite S3 (“La Galérie Parisienne”) a boarding satellite for
Terminal 2, was completed in June 2007, adding space for an extra 8.5m passengers.
The reconstructed Terminal 2E, a refurbished CDG1 and a new terminal for Air FranceKLM’s regional airline subsidiaries will be completed in 2008, adding capacity for a further
10.9m passengers (19.4m in total). These are served by a new light rail system
connecting the terminals and a new automatic baggage handling system under Terminal
2. More importantly, the number of contact stands for Air France is rising dramatically and
brings an A380 docking capability. This greatly improves efficiency for the airline and
significantly reduces internal airport transport and passenger transfer costs.
KLM similarly enjoys unconstrained infrastructure capacity at Amsterdam-Schiphol, with
its new terminal, five runways and direct road and rail links into Europe.
Long-haul growth: is the cycle stronger for longer?
The infrastructure for growth is therefore available but the questions arise as to whether
the cycle will be stronger for longer and therefore whether growth in demand will
remain at high levels for the next few years. In our view, the key to this question is the
continuing impact of emerging economies on global growth. There is a lack of long-haul
capacity growth in emerging economies, which face massive investment in aviation
infrastructure (aircraft and airport infrastructure) to support anticipated economic
growth. In 2006/07, total long-haul passenger traffic growth was 5.2% while capacity
rose by 4.2%.
Table 7: Growth in scheduled passenger revenues by destination
Destination
Europe/North Africa
Caribbean/Indian Ocean
Middle East/Africa
Americas
Asia/Pacific
Total
03/04*
04/05
Growth
(%)
05/06
Growth
(%)
06/07
Growth
(%)
4,525
1,023
1,058
1,850
1,009
9,465
6,049
1,123
1,923
2,942
2,062
14,099
34
10
82
59
104
49
6,689
1,157
2,216
3,469
2,371
15,902
11
3
15
18
15
13
7,079
1,201
2,362
4,013
2,686
17,341
6
4
7
16
13
9
Source: Company, Exane BNP Paribas estimates *pro-forma
18 Air France-KLM
The previous table shows the growth in revenues by destination since the merger. The
figures for 2004/05, the first year of the merger, show that KLM brought to Air France a
strong rise in revenues on routes to the Asia-Pacific region (+104%), Middle East/Africa
(+82%) and the Americas (+59%). Given the proportionately higher long-haul business
of KLM, the increase in revenues on European routes was less spectacular (+34%).
Table 8: Long-haul capacity and demand growth, 2007e–2011e
Country/region
Demand growth
Air France-KLM
capacity growth
6.2
8.3
4.8
7.7
8.0
12.0
5.0
4.5
8.0
4.5
3.5
11.0
14.5
8.0
Europe
Latin America
Africa
Middle East
India
China
Japan
Source: Company, Exane BNP Paribas estimates
The preceding table shows Air France-KLM’s medium-term demand and capacity
forecasts by region through to 2011. The notable feature is the heavy emphasis on
capacity growth in the emerging economies in Latin America (where Air France-KLM
already jostles with Iberia for the number one position), India, China and also Japan. In
the fast-growing areas of India and China, capacity is expected to grow ahead of
underlying demand in percentage terms, as the group intends to increase its market
share. This is also true of Japan, where Air France-KLM already enjoys a leading
position. In the latter case, this may also relate to the fact that the group plans to serve
the Japanese market with daily services using the A380 (as the next chart shows, the
first deliveries are scheduled in 2009).
Chart 5: Schedules of A380 deliveries to main European customers
12
10
5
8
4
6
4
3
3
2
6
4
2
3
Air France
1
1
1
0
2009
6
2010
British Airways
2011
2012
Lufthansa
2013
2014
Virgin Atlantic Airways
Source: Exane BNP Paribas
Air France-KLM has been in talks with Chinese airlines for some time to establish codeshares, which would increase connectivity of passengers into the Chinese domestic
market and a cargo joint venture, and code sharing on passenger flights is being
established with China Southern.
19 Air France-KLM
Consolidation underpins asset utilisation improvements
Consolidation and the generation of significant network scale effects following the
merger was the main driver of the improved asset utilisation of Air France-KLM and the
trend towards increased earnings and margins. In our view, it is also a major factor
allowing Air France-KLM to sustain the yield increases which have compensated for the
higher price of fuel. The table below shows that the greater economies of scale brought
by the merger have contributed to a 13% improvement in aircraft utilisation (sales/fleet
assets) and a more than doubling of the EBIT margin on fleet assets since the merger
at the beginning of 2004/05.
Table 9: Improving asset utilisation trend since merger
%
01/02
02/03
03/04
04/05
05/06
06/07
07/08e
08/09e
168
3
174
3
177
2
183
5
195
8
200
11
200
12
201
14
Sales/fleet assets
EBIT/fleet assets
Source: Company, Exane BNP Paribas
Our projections envisage rising synergies and ongoing structural cost reductions which
should raise Air France-KLM’s restated EBIT margin progressively, from 2.9% for Air
France standalone in 2003/04 (i.e. a cyclical low point) towards the 10% level for the
merged group that we believe can be achieved by a network carrier in a consolidated
airline industry over the economic cycle. The merger has given the group a strong
position in the European passenger business, with around one third more business (in
terms of RPKs) than either BA or Lufthansa. It has also created an effective challenge
to Lufthansa in cargo/logistics and maintenance.
Load factors can rise further
Despite having attained very high levels, we expect Air France-KLM’s seat load factor
to improve further in 2007/08, by about 1 point. This is because demand remains
strong and the group is developing long-haul routes faster than short-haul routes (longhaul routes have structurally higher load factors). This supports our view that the
airline’s earnings cycle has further to go, prompted by constrained capacity and the
introduction of new operating efficiencies.
The company continues to project a favourable yield environment in 2007/08, with
strong demand and constrained capacity deployment by European airlines.
Consequently, we do not see a situation of over-capacity developing on long-haul
services from Europe until at least 2009/10.
In our view, the “consolidation” business model will continue to produce earnings
growth and margin improvements well beyond the initial merger period. The next phase
is the integration of activities under a streamlined management structure, which is
focused on continued productivity gains.
The question is whether this can be replicated again with the recently announced joint
venture with Delta and with a possible merger with smaller airlines such as Alitalia or
Iberia, also creating significant value added? We go on to explore this in the next
sections.
20 Air France-KLM
Chart 6: Scheduled widebody deliveries worldwide
1,200
1,000
800
600
400
200
0
2001
2002
2003
2004
2005
2006
2007e 2008e 2009e 2010e 2011e 2012e 2013e
Source: Exane BNP Paribas estimates from industry and company data
21 Air France-KLM
Delta JV: taking advantage of Open Skies
In the global airline industry, one clear form of consolidation is through capacity-sharing
joint ventures, which restrict the amount of capacity that is introduced on selected
routes or “sub-systems”. In late October 2007, the Air France airline announced a
major new joint venture with Delta which is initially aimed at targeting the premium yield
market for business travellers from the US to London-Heathrow. Air France-KLM has
applied for four-party anti-trust immunity for Air France and KLM with Delta and
Northwest (and also for Alitalia). It expects to have a new joint venture structure in
place with Delta by the end of 2007, followed by Northwest afterwards. This could
strengthen considerably the position of SkyTeam on transatlantic routes where it
currently trails BA/oneworld and Lufthansa/United Airlines. We expect this to be a
major source of revenue growth, complementing the strong organic revenue growth
that we expect to see on Asian and Latin American routes.
The new joint venture constitutes a positive development for Delta, which was hitherto
blocked from entering the lucrative US-Heathrow market because of the restrictive
Bermuda II agreement between the UK and the US. It is also positive for Air France,
which has an (almost) asset-free way of developing its presence in the US–Europe
transatlantic market, where it currently trails both BA and Lufthansa. It is expected that
KLM will follow suit with the announcement of a joint venture with Northwest airlines on
routes from the US to Heathrow, building on their existing joint venture on routes from
the US to Amsterdam-Schiphol, which has been in place since 1993 and currently has
structurally high margins.
It is intended that, following approval of anti-trust immunity, all four airlines will share a
common four-party joint venture.
Air France/Delta announcement is a virtual merger
On 17 October, Air France and Delta signed an agreement to extend their joint venture
across the Atlantic. The two airlines already have anti-trust immunity on routes between
the US and France, which permits them to cooperate on pricing, capacity and routes. JC Spinetta, Air France-KLM’s President and CEO, confirmed that slots operated by Air
France and KLM at Heathrow will be available to their respective alliance partners,
Delta and Northwest, to operate direct flights between London and the US, probably
through a series of joint ventures. It was also confirmed that 9 of 12 top point-to-point
destinations to the US from Europe are from London-Heathrow.
In our view, Open Skies will lead to an increased interest in cooperation between those
alliance partners which enjoy anti-trust immunity. This should also reinforce the
consolidation effects on aircraft capacity levels, since closer cooperation implies joint
targeting of routes, frequencies and seats on offer.
22 Air France-KLM
Chart 7: Delta JV – new routes US–London Heathrow and US–Europe following Open Skies
Heathrow
Paris CDG
NW (MSP)
AA (BOS)
UA, AA (ORD)
Lyon
NW (DTW)
AA, DL, CO (JFK, EWR)
DL (SLC)
Paris
Orly
US (PIT)
UA (IAD)
UA (SFO)
DL (CVG)
AA / UA (LAX)
US (CLT)
NW (MEM)
DL (ATL)
AA, DL(DFW)
SKYTEAM ALLIANCE
Delta
Northwest
Air France-KLM
Joint venture
CO (HOU)
Code share
AA (MIA)
Continental
Source: Exane BNP Paribas from company information
From April 2008, Air France and Delta plan to extend revenue and cost sharing on
routes across the Atlantic to 19 daily flights which is equivalent to around 45,000 seats,
a 45% increase. The new routes will take advantage of the Open Skies agreement,
which has opened Heathrow up to competition from all carriers on transatlantic routes.
The second phase of the agreement will take place from 2010 and will include all
transatlantic flights operated by Air France and Delta between Europe and the North
America. This is as close to a full merger as can be achieved under the current
ownership restrictions (no more than 25% of a US airline and no more than 49% of an
EU airline may be foreign-owned).
Air France/Delta agreement creates 4 new daily Heathrow-US routes
The first phase of the agreement will include all non-stop flights operated by Air
France’s hubs at Paris-CDG, Paris-Orly and Lyon, and Delta’s hubs at New York-JFK,
Cincinnati and Salt Lake City. This will strengthen both airlines’ market position
between the US and Europe by adding many more connection possibilities. However,
the major new element is the direct assault on the lucrative Heathrow market. Using
part of the reconfigured B757 fleet and some B767-300s, Delta will begin double-daily
Heathrow–New York (JFK) flights and a daily Heathrow–Atlanta service. Frequencies
on these routes are expected to be increased in the next few years. Air France will
launch a daily Heathrow–Los Angeles route. The slots for Delta’s and Air France’s
routes will come from Air France, which plans to reduce frequency on Heathrow–Paris
flights now that there is greater competition from the Eurostar train, with journey times
down to just 2 hours and 20 minutes from mid-November 2007 following the opening of
the new high-speed link in the UK.
23 Air France-KLM
The chart below shows the change to market share on Heathrow–US slots implied by
the joint venture announcement by Air France and Delta. Although BA’s market share
only declines from 54% to 46%, this is clearly just the first step towards a significant
increase in competition at Heathrow on transatlantic services which, in our view, will
bring the price structure of business class fares down by around 15%. The slots for the
Delta services are being provided by Air France on lease. BA derives around 65% of its
EBIT from its Heathrow–US services and faces the prospect of yield erosion on its
business class fares. We estimate that the financial impact to BA of a 15% reduction in
its transatlantic Club World (business class) fares is around GBP70m per annum.
Conversely, the Air France/Delta joint venture should see a rise in yields on those
routes relative to the existing operations of Delta based at Gatwick and the services of
Air France from Paris to the US, given the yield differential between Heathrow–US and
other European cities to the US.
Chart 8: London Heathrow–US traffic market shares
Pre Open Skies
Post Open Skies
Delta
3%
United
13%
Northwest
3%
Air France
1%
Continental
4%
United
12%
American
17%
British
Airways
54%
Virgin
Atlantic
16%
British
Airways
46%
American
17%
Virgin
Atlantic
14%
Source: Exane BNP Paribas estimates
KLM/Northwest expected to follow suit
We expect a separate announcement to be made by KLM and Northwest very soon to
add another two daily Heathrow–US flights. Both airlines enjoy anti-trust immunity on
transatlantic cooperation with each other and have a joint venture on routes between
the Netherlands and the US. We would expect Northwest to start operating services to
Heathrow from its hubs at Minneapolis and Northwest using KLM slots. These routes
would be operated on a revenue and cost share basis with KLM, in conformity with the
structure of the existing joint venture between the US and Europe. Together with the Air
France/Delta announcement, this would imply a total of six new daily flights between
Heathrow and the US in direct competition with BA, Virgin, United and American.
Furthermore, there is a high probability that Continental (a SkyTeam member) will
move its London–New York double-daily services from Gatwick to Heathrow.
24 Air France-KLM
Preliminary assessment of the earnings impact
We expect Air France-KLM to give new information on the transatlantic joint ventures at
its H2 2007/08 results conference on 22 November and subsequently as the route
plans are developed. The CEO of Delta, Richard Anderson, has already indicated that
the joint ventures could bring incremental pre-tax profit of USD125m–USD200m from
2011. The joint ventures are expected to operate in a manner similar the current joint
venture between KLM and Northwest, namely targeting 50% capacity by each partner
airline as far as possible, with revenues and costs pooled and a profit adjustment
(which can be either way) at the end of the year. Our estimates shown below assume
that the joint venture achieves a 6% operating margin in 2008/2009, rising to 8% in
2009/10 and 2010/2011, with traffic increasing by 6% per annum and yields stable. We
believe this is conservative given that, in our view, BA makes around 65% of its profit
on North Atlantic routes (i.e. on approximately 30% of its revenues), implying a margin
in excess of 15% (based on its 2006/07 earnings).
Table 10: Estimated Air France-KLM/Delta JV contribution
USDm
Revenues
EBIT
Operating profit share for AF-KLM
08/09e
09/10e
10/11e
11/12e
1,500
90
45
1,590
127
64
1,685
135
68
8,000
640
320
Source: Exane BNP Paribas estimates
If the same EBIT margin as our estimated margin for BA in 2006/07 (15%) on its North
Atlantic routes were applied to the same projected revenues, we estimate that the joint
venture’s EBIT would be USD225m in 2008/09, USD238m in 2009/10, USD253m in
2010/11 and USD1.2bn in 2011/12, when the perimeter of the joint venture is
expanded.
The structure of transatlantic partnerships
In our view, significant revenue gains for Air France-KLM are possible through joint
management of capacity on routes across the North Atlantic in cooperation with Delta
and Northwest Airlines following Open Skies after the end of March 2008. Open Skies
between the US and Europe does not threaten the “hub and spoke” operating model of
the three leading European network airlines, but it does offer scope to build the existing
airline alliances into a more valuable source of earnings. It is more ambitious than
KLM/Northwest and envisages revenues of EUR1.5bn in 2008/09, rising to EUR8bn
from 2010/11.
The current joint venture arrangement between KLM and Northwest relates to
operations on the North Atlantic routes, the routes between the Netherlands and India
and related feeder routes. It relates to all passenger and cargo traffic and the routes
cover all air traffic between the US, Canada and Mexico on the one hand and Europe
on the other. Each partner contributes the difference between its traffic revenues and
operating expenses to the joint venture and shares on a 50:50 basis in the total
contribution generated. The assets (including aircraft) used in the joint venture are
managed separately by the two airlines, while the related operating expenses are part
of the joint venture. Typical annual transfer amounts have varied been EUR75m and
EUR150m in earnings. Revenues from the joint venture were USD2,313m in 2000/01.
25 Air France-KLM
The relationship of Air France with Delta Air Lines was originally negotiated in June
1999. Air France’s alliance with Delta, which was followed by an ‘Open Skies’
agreement between France and the US, expanded the number of connecting
opportunities for Air France in the US from nine to 110 over a three-year period,
drawing potential European passengers seeking US destinations away from competing
networks and leading to an increase in Air France’s overall AEA market share at the
time from 14% to 17%. The relationship was strengthened further following the granting
of anti-trust immunity on North Atlantic routes in January 2002 to Air France and the
other European SkyTeam members (Alitalia and CSA Czech Airlines) for their alliance
with Delta on North Atlantic routes. Anti-trust immunity was extended to SkyTeam
members, including Korean Airlines, on Pacific routes, in June 2002. KLM, Northwest
and Continental Airlines became part of the SkyTeam Alliance in September 2004.
The prospect now is of intensification of the SkyTeam connections and shared antitrust immunity, so as to reinforce the profitable network across the Atlantic from
Amsterdam and Paris and extend its scope via joint ventures for example from
Heathrow.
Background to the relationship with Alitalia
A joint venture has operated between Air France and Alitalia since April 2002, with a
focus on the Italy–France ‘bundle’ of routes. It is designed to optimise operating profits
from passenger traffic between France and Italy by coordinating flight destinations and
frequencies as well as aircraft types and crew rosters. J-C Spinetta (Air France-KLM’s
President and CEO), joined the Board of Alitalia from 2002 and was a member until the
first auction process was launched in 2006. He is therefore very well aware of the value
of Alitalia (or lack of value, if the correct restructuring measures are not allowed to be
taken).
On 30 September 2003, Air France, KLM and Alitalia entered into a tripartite agreement
listing the conditions and principles under which to conduct a three-way commercial
alliance.
The original joint venture with Air France was cemented by the purchase of a 2%
shareholding by each company in the other. It is focused on trunk routes into and out of
Italy, on both premium and leisure traffic. As displayed in the chart that follows, these
routes connect Alitalia’s twin hubs at Milan and Rome and other Italian cities with ParisCDG, and also Air France’s secondary hubs at Lyon, and Marseilles. Point-to-point
routes are also operated to major cities such as Toulouse, Nice and Strasbourg.
Air France and Alitalia also cooperate on long-haul business across the Paris hub,
given the developing sophistication of Air France’s connecting network through ParisCDG and Alitalia’s funding constraints and the relatively underdeveloped nature of its
long-haul fleet network. The framework for sharing the economic benefits from joint
ventures on specific routes was established in July 2001, with a profit-sharing formula
of 60:40 in favour of Air France initially (reflecting its network contribution), reverting to
50:50 after three years.
26 Air France-KLM
Chart 9: Air France and Alitalia – joint venture route map
Source: Company data, Exane BNP Paribas
Air France-KLM has continued to benefit from the relationship, both through
cooperation on bilateral routes (services between France and Italy were extended to
ones to Italy to the Netherlands in 2004) but also from the combined group’s increased
direct commercial presence in the Italian market.
The problem for Alitalia’s current shareholders is that much of the potential value of
Alitalia is inherent in what a merger partner brings to the turnaround plan (as was the
case for KLM and Swiss), not in the business of Alitalia itself as it exists at present.
In our view, the Italian business could be very profitable for Air France-KLM but could
also be conducted independently from Alitalia using Air France-KLM’s capacity alone,
even though this would progress more slowly. The joint venture with Alitalia has not
impeded Air France-KLM’s ability to build up its own business in Italy and Air FranceKLM has already developed a strong network of frequencies to northern Italian
destinations from both Paris and Amsterdam.
In our view, Air France-KLM (and Lufthansa) are only potentially interested in Alitalia if
the latter’s fortunes are capable of being fully restored within a merged entity and the
investment is likely to be on actions required to turn round the business (i.e. investment
in the fleet) rather than investment in the existing assets.
We discuss our scenario analysis of the potential value added from Alitalia, based on
our estimate of what a turnaround plan for Alitalia could achieve, in the following
section.
27 Air France-KLM
Airline acquisitions: risk/return trade-off
Air France-KLM has stated that it is open to new consolidation opportunities, as it is now
clear from Air France’s merger with KLM and the takeover of Swiss International by
Lufthansa that full synergies in Europe’s airline business can only be delivered through
mergers, with immediate and substantial benefits in terms of revenue synergies and
improvements in asset utilisation, followed by both revenue and cost synergies over
several years following such mergers. Consolidation activity so far has shown that the
scale effects and improved asset utilisation have a positive impact on average margins. In
our view, the competitive environment after Open Skies will put great pressure on smaller
airlines with limited networks to seek to merge with larger partners, which have bigger
scale and stronger balance sheets. For Air France-KLM, the successful merger with KLM
has given the group considerable integration experience and we expect this to be
deployed by its participation in further consolidation.
Alitalia or Iberia, it’s a buyers’ market
The most immediate consolidation targets in the European airline industry (excluding
low-cost carriers) are Alitalia and Iberia, both of which have been put up for sale. We
expect that Austrian Airlines and SAS will attempt to negotiate entry into one of the
larger airline groups once their current restructuring programmes are at, or near,
completion. There has been some concern that Air France-KLM might overpay for
these assets in order to obtain market share.
In our view, there is no need for Air France-KLM to overpay for either company. Indeed,
J-C Spinetta (the group’s President and CEO) has said that he would not do a deal that
was not in the interests of shareholders. Moreover, he has further committed that any
deal should not jeopardise the group’s ability to achieve its 2009/10 post-tax ROCE
target of 8.5%. Each of the two airlines, Alitalia and Iberia, represents a different and
specific business opportunity and we believe it is worth reviewing the history of
engagement and the potential synergies and NPV benefits that we estimate can accrue
to Air France-KLM from each consolidation opportunity.
A summary of our analysis is set out in the table below. This shows that the potential
NPV benefits, based on our assumptions of the potential acquisition price, would be
greater for a merger of Air France-KLM with Alitalia than for a merger of Air FranceKLM with Iberia. Closer cooperation on a multilateral basis (rather than the present,
separate bilateral relationships between Air France and Delta and KLM and Northwest)
is a “win-win” situation which we estimate could potentially generate synergy benefits of
EUR625m for a merged Air France-KLM/Alitalia entity.
Table 11: Potential merger with Iberia or Alitalia – estimated merger synergies
EURm
Year one
Year two
Year three
Total
Estimated Air France-KLM/Iberia synergies
Discount applied at 7.5%
Discounted synergies
Value per share to Air France-KLM (EUR)
92
0.86
79
188
0.80
150
120
0.75
90
400
Estimated Air France-KLM/Alitalia synergies
Discount applied at 7.5%
Discounted synergies
Value per share to Air France-KLM (EUR)
100
0.86
86
297
0.80
238
228
0.75
171
319
1.06
625
495
1.65
Source: Exane BNP Paribas estimates
This is not included in our valuation and target price but shows the potential upside to
the share price if consolidation moves can be managed successfully.
28 Air France-KLM
Alitalia: currently a chronically sick company
Investors’ reaction to speculation about Air France-KLM’s possible interest in acquiring
Alitalia has frequently been negative, leading to short-term selling pressure on the
shares. In our view, this is misguided since it is apparent that Air France-KLM can
negotiate from a position of considerable strength and will not do a deal unless the
risks are minimised and the group has a significant chance of success. We recall the
negative sentiment at the time the KLM deal was negotiated in 2003 (when KLM was
loss-making), when Air France’s competitors commented that they had taken on an
unacceptable level of risk. Clearly, the risks are greater for a merger with Alitalia than
for one with Iberia, given the fact that Alitalia has accumulated losses, partly through
mismanagement and political interference. However, we would expect this to be
reflected in the respective takeout valuations of the two airlines. In our view, Iberia is
holding out for a valuation that is excessive given the poor outlook for its domestic and
European passenger business as it faces steeper competition (already reflected in yield
declines). For Alitalia, the situation is different, since we believe the value of the
company lies only in its turnaround potential.
Table 12: Alitalia – revenues and profit/loss trend
EURm
2001
2002
2003
2004
2005
2006
Revenues
EBITDAR
EBITDAR margin (%)
Operating result
Net profit (loss)
5,330
191
3.6
(291)
(907)
4,844
318
6.6
(119)
93
4,384
37
0.8
(384)
(520)
4,119
32
0.8
(402)
(812)
4,682
288
6.0
(47)
(167)
4,770
141
3.0
(266)
(626)
Source: Company, Exane BNP Paribas estimates
Air France-KLM continues to state that it is only interested in Alitalia if the conditions
are right and will allow Air France-KLM’s management to implement its turnaround
plan.
Alitalia’s financial condition remains weak
Alitalia remains in a very poor operating condition, despite the launch of several
turnaround plans in the past few years, a EUR1.2bn recapitalisation and the unsuccessful
Restructuring and Relaunch Plan in 2005.
Alitalia’s net debt amounted to EUR1,171m at end-September 2007, compared to
EUR988m at end-June 2007. Cash and liquid assets were EUR442m at endSeptember 2007, compared to EUR715m at end-December 2006. Gross debt
amounted to EUR1,613m. Capitalised operating leases are estimated at EUR1,225m
(EUR175m capitalised at 7x). This compares with net assets at end-December 2006 of
EUR886m (compared to EUR1,456m the previous year).
29 Air France-KLM
Chart 10: Alitalia’s net debt trend
1400
1171
1200
1006
988
EURm
1000
800
754
600
400
200
0
Dec-05
Dec-06
1
Jun-07
Sep-07
Source: Company reports, Exane BNP Paribas estimates
The business has continued to lose money during 2007 at a similar rate to 2006. The
H1 07 operating loss was EUR127m, compared to a loss of EUR130m in H1 06. The
net loss was EUR211m, compared to EUR220m in H1 06. A revised Business Plan for
2008–2010 (the “Survival/transition“ Plan) sponsored by the new Chairman, Dr.
Maurizio Prato, was approved in September.
Turnaround potential but will buyers pay for the option?
In 2002, we analysed the potential synergies resulting from Alitalia’s first joint venture
with Air France on the “bundle” of routes between Italy and France and beyond on
intercontinental services from Paris-CDG. The joint venture was targeted to achieve
EUR180m of synergies in four years, out of total joint venture revenues of EUR650m.
The potential synergies included EUR85m from the joint development of the
Italy/France network, EUR23m from coordinated operations to other destinations,
EUR10m from optimisation of the sales infrastructure, EUR38m from cargo operations
and EUR24m from other partnerships.
Our new assessment shows that a merger between Air France-KLM and Alitalia would
deliver significantly more synergies, especially given the much larger scale and scope
that has been achieved following the merger of Air France with KLM.
However, in our view, the realisation of value from Alitalia would require more than
identifying and realising synergies. It would require an entire reorganisation of the value
chain by the acquirer. In this sense, the value of Alitalia is limited to an “option value”,
which is contingent on the acquirer’s freedom to execute the actions necessary to
achieve a turnaround and acceptance by employees and unions of those actions.
Previous attempts to reorganise the company (the separation of Alitalia Express and a
de-merger of the maintenance and services business of AZ Servizi from the main
airline) have only had partial success because of a lack of support for a fundamental
restructuring of the network, reorientation towards the key business travel markets and
more fundamental cost restructuring.
30 Air France-KLM
Our approach is to look at the development of merger synergies between KLM and Air
France, which were relatively slow in the early stages compared to Lufthansa/Swiss
(partly because Lufthansa benefited from observing the pioneering Air France/KLM
experience) and extrapolating the benefits pro-rata to Alitalia’s revenues (approximately
two thirds of those of KLM at the time of the Air France-KLM merger). Using this
approach, we estimate that a merger of Alitalia with air France-KLM could bring
synergies of at least EUR77m in the first year, EUR234m in the second year and
EUR314m in the third year (in the case of KLM, the underlying earnings swing following
the merger was approximately EUR328m and in the case of Swiss, CHF353m).
However, we believe that with greater experience of the merger process, Air FranceKLM would seek to accelerate the realisation of synergies and a return of Alitalia to
profitability. Thus, we have adjusted the estimates, bringing forward 10% of the
synergies estimated for year two to year one and 20% of the synergies estimated for
year three to year two. This suggests potential improvements in profitability of
EUR100m in year one, EUR297m in year two and EUR228m in year three.
Table 13: Estimated synergies of Air France-KLM/Alitalia combination, based on
KLM’s pro-rata figures (years one to three of its merger with Air France)
EURm
Revenue synergies
Cost synergies
Total
Total pro rata (revenue multiple) (%)
Alitalia potential synergies
EURm
Revenue synergies
Cost synergies
Total
Cumulative
Synergies brought forward
Adjusted synergies
04/05
05/06
06/07
60
55
115
66.7
205
145
350
66.7
260
265
525
66.7
Year one
Year two
Year three
40
37
77
77
137
97
234
311
164
150
314
625
23
100
63
297
0
228
Source: Exane BNP Paribas estimates
Applying the synergies to our model for Alitalia suggests that Alitalia could be profitable
in year two and significantly earnings accretive by year three (consistent with the
experience of KLM, and, using a closer comparison in terms of the balance of short and
medium-haul networks, with Swiss International). The estimated impact on earnings
would be for Alitalia to show an EBIT loss of EUR17.7m in year one (2008) and an
EBIT profit of EUR139.5m in year two (2009).
We go on to analyse the sources of potential synergies with Alitalia, based on our
conversations with the management of Air France and KLM (which had a potential
merger agreement with Alitalia in 1998) as well as discussions with Lufthansa.
Air France and KLM had identified the sources of synergies in the early stages of the
merger in May 2004 shown in the following table.
31 Air France-KLM
Table 14: Air France-KLM – initial sources of merger synergies
EURm
Year 1
Year 3
Year 5
10
40
100
30-35
95-130
130-195
10
35
35
10 to 15
25
60-65
IT Systems
Convergence of IT systems
5
20
50-70
Other
Joint purchasing
0
5 to 10
10 to 30
65-75
220-260
385-495
Sales/Distribution
Coordination of sales structures
Reduction in sales/handling/catering costs
Network
Optimisation of networks & schedules
Harmonisation of revenue management
Optimisation of fleet deployment
Coordinated management
Cargo
Optimisation of networks
Coordination of sales policies
Sales cooperation
Maintenance
Purchasing
Insourcing of subcontracted work
Pooling of spares
Total
Source: Company, Exane BNP Paribas estimates
These synergies rose substantially in subsequent years, as management teams at
airline saw additional opportunities for maximising revenues cutting costs.
Sources of potential synergies
Route network
Alitalia’s operating weakness stems, in large part, from falling traffic levels and lower
yields. This is because Alitalia’s network includes a large number of routes where seat
load factors are too low or yields are challenged by increasing competition.
Reorientation of the networks, followed by access to Air France-KLM’s sales and
marketing network, would bring immediate benefits. We believe the first step would be
to restructure the route networks, trimming unprofitable routes. This includes a large
part of the domestic business. The example of Air France-KLM itself shows that, apart
from a small number of dense traffic shuttle routes on point-to-point destinations,
domestic services need to be focused on feeding transfer passengers to international
connecting opportunities.
32 Air France-KLM
Hub selection
It is difficult to see a full-scale mega-hub becoming established in Italy following the
creation of comprehensive links by Lufthansa between individual north Italian cities and
Frankfurt and Munich (and prospectively Zurich) and competing networks established
by Air France and KLM through Paris and Amsterdam respectively. The capital
expenditure on long-haul fleet required to establish a fully competing long-haul hub and
spoke network based on Milan or Rome would be enormous and also uneconomic.
Rome also faces the problem that it is primarily a major destination for tourism and
visits to the Vatican, etc., but not a major centre of business. In our view, the most
efficient system would be to link Milan and Rome more closely with Amsterdam and
Paris in order to improve the destination network and frequencies for Italian business
travellers, while restricting long-haul point-to-point services to those destinations with
heavy natural traffic flows.
Benefits from larger corporate accounts/Frequent Flyer Programmes
As we saw from the KLM merger (and are also seeing in the case of Swiss at
Lufthansa), many of the synergy benefits from airline mergers result from the
advantages that the larger partner brings in terms of balance sheet strength (enabling
fleet modernisation and improved fuel hedge cover, as well as lower debt financing
costs), access to Europe-wide corporate accounts and a leveraging of the worldwide
schedules and network of destinations. This is likely to lead to significant improvements
in seat load factors and rising asset utilisation.
Fleet changes
Major savings could be derived from fleet changes. The ability to improve the fleet’s
cost structure and suitability was one of principal reasons why KLM actively sought a
merger in 2003. The fleet age and structure of Alitalia is significantly worse than that of
KLM in 2003, and thus the potential earnings leverage from an overhaul of the fleet is
even higher, in our view, even if the management challenges are also significantly
greater. Alitalia has a fleet of 30 long-haul aircraft (at end-December 2006), including
10 B777s, 15 B767s and 5 cargo MD11s, along with 156 short or medium-haul aircraft.
At end-December 2003, KLM had a fleet of 54 long-haul aircraft (22 B747-400s, 2 B747
freighters, 4 B747-300s, 4 B777-200 ERs, 10 MD11s and 12 B767-300ERs) and 70
medium-haul aircraft, mainly of the B737 family plus 54 regional aircraft. Following the
merger with Air France, KLM undertook an active fleet replacement programme
focused on the long-haul aircraft (predominantly replacing 2 engine B777s with older 4
engine B747s). This had a strongly positive effect on both asset utilisation and fuel
costs. Alitalia has the problem of having too many aircraft types (12 types) which
increase maintenance and pilot training costs. It also has a large number of old aircraft,
especially 70 Boeing MD-82s and several cargo MD11s which have a high degree of
fuel inefficiency.
Fuel cost hedging
At present, Alitalia’s fuel hedging programme is weak. Hedge cover negotiated under
the Air France-KLM umbrella would lead to lower actual fuel costs, as was evident, for
example, from the hedge cover extended to Swiss International by Lufthansa (KLM
already had an effective hedge programme when it merged with Air France but the
structure was further improved by combining the best practices of both airlines).
33 Air France-KLM
Maintenance and depreciation
Alitalia’s maintenance and depreciation costs would appear to be significantly higher
than those of its peers. At present, Alitalia’s aged fleet is maintained by AZ Servizi
under what appear to be highly-priced contracts. Switching these contracts to Air
France-KLM’s maintenance and engineering or to outside contractors would provide
immediate benefits.
Information technology
Information technology is a major potential source of revenue and cost synergies. We
believe that rapid advances could be made in this area, given the extensive work on
technology integration done by teams from Air France and KLM in the last few years
and the current migration of KLM’s system to Amadeus-based applications.
Purchasing/contract renegotiation
The separation of Air Servizi from Alitalia’s airline operations has had a positive effect
on staffing, reducing personnel from 18,780 at the end of 2005 to 11,465 at the end of
2006. However, Alitalia has been saddled with continuing handling and services
contracts with Air Servizi, which we believe are on highly disadvantageous terms.
Cancellation of these contracts and an open tender for the materials and services
would assist greatly to create a firm platform for profitability.
Personnel/productivity improvements
Trimming the workforce through restructuring has exchanged direct labour costs for
indirect labour costs (through services contracts with AZ Servizi). Alitalia’s productivity
levels in the passenger business are lower than its peers and significant changes
would need to be made to working practices, as well as a reduction of headcount.
Financing costs
Financing costs would be reduced given the much stronger credit status and lower debt
financing costs of Air France and KLM. Alitalia’s fleet rental costs are significantly
higher than its peers, which we believe relates to the cost of operating leases following
the sale and leasebacks in times of difficulty, when Alitalia was attempting to raise cash
prior to the capital raising. Refinancing of a large proportion of the operating leases
could provide substantial savings.
Sales/marketing costs
Our analysis indicates that Alitalia has exceptionally high sales/marketing costs per
passenger. These could be reduced significantly by joining the Air France-KLM
distribution system. In our view, the greater selling power of a larger network with more
frequencies would lift quickly the passenger revenues of Alitalia, currently one of the
main problems of its operations.
Best-case scenario: valuation of EUR0.42 per share
Our analysis, using the assumptions about possible synergies, shows that a turnaround
of Alitalia is possible by a larger airline group such as Air France-KLM giving a DCF
valuation for Alitalia’s equity of EUR576m or EUR0.42 per share. It should be
emphasized that this is not the value which we believe Air France-KLM would pay for
Alitalia but the value which, on best base assumptions, could be created by Air FranceKLM for their shareholders (the shareholders of the enlarged Group) if management
time and capital is invested in a turnaround.
34 Air France-KLM
Worst-case scenario: zero value
In our view, the worst-case scenario would be that the Italian government would not
allow an acquirer the freedom to make the changes necessary to achieve a turnaround
and Alitalia’s employees and labour unions would not cooperate with a turnaround plan,
Alitalia would continue to lose passengers, the operating losses would continue and the
airline would be closed down. Our assumption is that Alitalia will not be able to achieve
a turnaround on its own, as the main requirement is for a business plan based on the
needs of Italian businessmen for efficient airline connections to the rest of the world,
rather than for one that would compete head-to-head with low-cost airlines on shorthaul routes, a strategy which can never succeed. Our worst-case scenario is that
Alitalia’s liabilities could exceed its assets (net debt of EUR1,171m plus average
closure costs of EUR100,000 per employee multiplied by 11,465 employees, so
totalling EUR1,146m) plus a provision of EUR100m for termination of the Servizi
contracts, implying total liabilities of EUR2.4bn. This would compare to fleet assets and
property on the balance sheet of EUR2.34bn (before taking into account the necessary
fire-sale discount).
Possible deal structure
Given the risks of the worst-case scenario materialising, we believe the approach taken
by a possible acquirer of Alitalia, whether this is Air France-KLM or another airline, is
likely to be to shift the financial risks as far as possible onto the Italian government and
other existing shareholders.
As in the case of the performance-related Earnout bond used in the Swiss International
takeover by Lufthansa, or the warrant incentive offered by the new Air France-KLM
holding company to KLM shareholders, a large part of the payment for Alitalia would
probably be on a deferred or performance basis, with management time and
investment in fleet assets, for example, being the main immediate contribution, rather
than cash. This would minimise the financial risks while offering significant upside
potential.
Iberia: main risk is overpaying
The situation in respect of Iberia is completely different from that of Alitalia. We believe
the potential NPV benefits to Air France-KLM from an acquisition of Iberia could be
lower than from an acquisition of Alitalia. The main reason for this is that there are
more overlaps between Iberia and Air France-KLM in respect of Iberia’s most valuable
business, namely the Europe-Latin America network and we believe these are already
priced into the company’s market value. Approximately one third of Iberia’s flight
revenues (but most of its profits) are derived from routes to Latin America, one third are
derived from domestic airline operations and one third come from medium-haul flights
to Europe and North Africa. The other main factor restraining value creation from Iberia
is that it is a profitable and relatively well-managed business, even if a large part of its
business is in slow decline as competition from low-cost carriers increases. Iberia can
therefore currently justify higher acquisition multiples than Alitalia, where by contrast a
restoration of profitability is dependent on the successful management of integration by
an external partner such as Air France-KLM.
35 Air France-KLM
Iberia is in good health but with peaking earnings
While Iberia has a solid and sustainable business in its strong long-haul network to
Central and South America, we would ascribe little value to the airline’s domestic and
medium-haul passenger airline businesses, which face strong competition from lowcost carriers. However, Air France-KLM also has its own strong business to Latin
America and can continue to build this organically, with limited risk. This limits the
potential for synergies and in our view, Air France-KLM is only likely to participate in an
auction of Iberia if the main financial risk is taken on by third parties. A possible
scenario in this case would be for Air France-KLM to be a minority investor with limited
financial exposure together with Spanish or other co-investors, who would be the main
financial investors. On a pure operating basis, we value Iberia at no more than
EUR3.04 per share (EUR2.70 per share in intrinsic value through the DCF approach,
plus EUR0.34 per share in possible synergies). We therefore see a bid for Iberia
significantly above EUR3 per share as being highly unlikely, with the risks of erosion of
its domestic and medium-haul businesses through competition with low-cost carriers
continuing to rise. Iberia needs to operate within the framework of a larger-scale airline
organisation, as we believe its own management recognises.
Based on a scenario where Air France-KLM would pay about EUR2.89bn (equating to
EUR3.04 per share) for Iberia’s equity and would absorb the company’s EUR2.6bn of
net debt (including capitalised operating leases), we see the potential for value creation
in NPV terms for Air France-KLM at EUR319m. We summarise this in the table that
follows.
Table 15: Estimated synergies of an Air France-KLM/Iberia combination
EURm
Air France-KLM synergies
Estimated Air France-KLM/Iberia synergies
Discount applied at 7.5%
Discounted revenue synergies
Value per share (EUR)
Standalone value of Iberia (with property) (EUR)
Value of Iberia with synergies (EUR)
Year 1
115
92
Year 2
235
188
Year 3
150
120
0.86
79
0.80
150
0.75
90
Total
500
400
319
0.34
2.70
3.04
Source: Exane BNP Paribas estimates
We have assumed that there would be greater overlaps between the businesses of Air
France and Iberia which would require a reduction of services by competition
regulators. We therefore estimate only 80% of the merger synergies to Air France-KLM,
to arrive at a discounted total of EUR319m or EUR0.34 per share. Based on our
standalone DCF valuation for Iberia of EUR2.70 per share, this implies that a deal
could be value accretive for Air France-KLM at up to EUR3.04 per share. The risks
would be significantly lower than a deal with Alitalia. Nevertheless, the upside would be
limited to any future organic growth and the structure of the financing of any deal.
36 Air France-KLM
Moving towards the 8.5% ROCE target
Sustained earnings growth and margin improvement
Air France-KLM has shown sustained improvements in operating income and in the
operating margin since the merger. The significant uplift was in 2005/06, but the strong
increase in the share price did not take place until further evidence of the margin uplift
was shown in each quarter of 2006/07, despite a strong rise in fuel costs.
Table 16: Sustained margin growth following the merger
y/e March
Operating income (EURm)
Adjusted operating margin (%)
Margin improvement (%)
03/04
04/05
05/06
06/07
07/08e
363
3.1
nm
553
3.8
0.7
936
5.4
1.6
1240
6.3
0.9
1480
7.0
0.7
Source: Company, Exane BNP Paribas estimates
In our view, while Air France-KLM clearly remains exposed to the economic cycle and
general capacity conditions in the industry, especially the long-haul industry,
nonetheless there is a structural element to the margin development which relates to
the economies of scale created by the larger grouping and the higher asset utilisation
that relates to the use of the long-haul hub and spoke systems. In parallel with this,
there are cost cutting/productivity elements relating to new common IT systems and
functions (such as e-ticketing and on-line check in) as well as the advantages of the
lower-cost new-generation aircraft, which mean that the margin progression has a
structural element.
Recent earnings performance and growth outlook
Air France-KLM’s Q1 2007/08 revenues showed a 2.5% rise to EUR5,945m while
operating income was 1% higher at EUR415m. Net profit rose 70.1% to EUR415m or
by 20% to EUR293m excluding one-off items. Full-year guidance of a further rise in
operating income and a 7% post-tax ROCE was maintained.
Table 17: Q1 2007/08 results summary
EURm
Revenues
Operating income
Income from operating activities
Pre-tax income
Net income
Net EPS (EUR)
EPS (diluted) (EUR)
Q1 06/07
Q1 07/08
% change
5,802
411
388
310
244
0.92
0.86
5,945
415
537
603
415
1.49
1.34
2.5
1.0
38.4
94.5
70.1
62.0
55.8
Source: Company
The group’s adjusted operating margin declined by 0.3 percentage points to 7.8%
which some market observers took to be the end of the margin improvement trend. Net
profit was 70.1% higher at EUR415m, following EUR122m in one-off items (EUR40m
from the sale of Alpha Airport shares and EUR82m from the capital reconstruction of
WAM/Amadeus).
37 Air France-KLM
We believe the market overreacted to the pause in improvement in the operating margin.
In our view, the Q1 results showed only a temporary pause in the trend to margin
improvement and a higher ROCE/WACC, largely because of a number of one-off factors.
In particular, the Q1 results saw the negative effects of 15 days of extended public
holidays and the presidential elections in France when business travel was curtailed.
This had a significant yoy effect on profitability in May but there will be no such effect in
Q2 2007/08. Since May, there has been a strong pick-up in profitability in the
passenger business and as confirmed recently by the President and CEO, Jean-Cyril
Spinetta, forward bookings for Q3 are good.
Passenger business: the main earnings driver
The main driver of the earnings improvement is the strong development of the
passenger business, which represents 80% of revenues compared to 64% for
Lufthansa and 85% for BA. Passenger operating income rose by 56% to EUR1,067m in
2006/07 and represented 86% of operating income. There is a proportional increase in
long-haul business and strong growth in high-yielding long-haul premium traffic as Air
France-KLM has extended its catchment area across the European Continent (and into
the UK).
Chart 11: Operating profit by activity, 2006/07
Maintenance
4%
Transavia/catering
5%
Cargo
5%
Passenger
86%
Source: Company, Exane BNP Paribas
The passenger business continues to perform well. In Q1 2007/08 operating income in
the passenger segment rose 9.1% to EUR396m from EUR363m and the operating
margin increased by 0.4 points to 8.3% from 7.9%. The rise in total operating income
by 1% to EUR415m was held down by an 8.3% rise in fuel costs and a 4.1% increase
in employee costs (partly one-off) relating to the last month of higher UNEDIC
payments. There was also a 31% increase in maintenance costs to EUR264m (an
actual cost increase of EUR63m) offset by a decline in depreciation reflecting the shift
in treatment of maintenance activities.
38 Air France-KLM
Other divisions: mixed earnings performance
The profit performance of the other divisions, which represent 20% of revenues and
14% of operating profit, was mixed. Cargo performed poorly, continuing the downturn in
profitability shown in Q3. Full-year cargo earnings fell by 63% from EUR166m to
EUR62m. This will be countered with planned reductions in capacity and replacement
of high fuel cost with lower fuel-burning aircraft. Maintenance showed a yoy decline in
profitability to EUR40m from EUR54m but Catering and Transavia doubled profits to
EUR67m from EUR30m. Transavia’s new joint venture with Air France from Paris is
already showing considerable promise in terms of bookings and web “hits”.
Cargo outlook is improving
Cargo’s performance (12.6% of revenues, 5% of operating profit) has remained weak, as
yields remain low and the price of fuel makes older aircraft uneconomic. In 2006, trade
growth on Asian routes was 8%, ocean freight grew by 16% but air freight rose by only
4%. Remedial action is therefore being taken by Air France-KLM’s cargo management.
This involves reductions in cargo capacity and a re-examination of the strategic options
for the medium term such as a focus on higher value-added Express business, B777300s to replace B747 combis, interim use of MD11 freighter aircraft and a bigger focus on
belly capacity.
In Q1 2007/08 there was continuing weak performance in Cargo, and the net currency
effect on operating profit was worse than usual. Cargo revenues declined 5.5% and the
operating profit in Cargo went from a profit of EUR28m to a EUR17m loss. However,
signs of a recovery have already become apparent in July. Currency effects, mainly the
weaker dollar reduced the yield expressed in unit revenue per EASK by 2.7% from a
positive 1.8% to a negative 0.9% and because of the structure of the fuel hedge
position there was less of a corresponding benefit to USD-priced fuel costs.
ROCE target achieved earlier than anticipated
As a result of the underlying business improvement, Air France-KLM is reaching its 7%
post-tax ROCE target far earlier than expected and at a lower EBIT margin than
anticipated. The trend is for a further improvement this year to 7% after 6.5% in 2006/07.
The target for 2009/10 is for a post-tax ROCE of 8.5%. We examine below the synergy
and cost-cutting developments that continue to support the improvements in margins.
39 Air France-KLM
Merger synergies underwrite margin improvement
Synergies have been a significant driver of the improvement in operating margin and
the synergy targets were again upgraded for 2007/08 onwards, mainly based on the
process improvements resulting from the implementation of joint IT platforms:
Chart 12: Revenue and cost synergies
1,200
9%
8.4%
8%
1,000
7%
7.4%
800
6%
6.8%
EURm
555
475
600
425
360
400
5%
4%
3%
265
200
260
305
325
06/07
07/08e
08/09e
390
445
09/10e
10/11e
2%
1%
-
0%
Revenue (cum)
Cost (cum)
Adj EBIT margin (Exane BNPP estimate)
Source: Company, Exane BNPP estimates
Core profitability: benefits of synergies
Synergy targets were raised to EUR1bn by 2010/2011 compared to a previous target of
EUR670m by 2008/09 (and an original estimate of EUR400m–500m). The point is that
revenue improvements and cost savings are continuously being identified, as there is
greater coordination and integration and this is acting as a major driver of the earnings
and margin improvements. While we have assumed rising margins going forward, this
does not yet take into account the assumption of synergies higher than EUR1bn by
2010/2011.
Table 18: Revenue and synergy targets
EURm
Revenue synergies
Cost synergies
Total
04/05
05/06
06/07
07/08e
08/09e
09/10e
10/11e
60
55
115
205
145
350
260
265
525
305
360
665
325
425
750
390
475
865
445
555
1,000
Source: Company, Exane BNP Paribas estimates
40 Air France-KLM
Paris-CDG new terminal facilities lower costs
Air France-KLM will enjoy an airport capacity expansion at Paris-CDG equivalent to
around two thirds of the passenger handling capacity of T5 at Heathrow at the same
time as commissioning of T5 (the expansion is Satellite S3, full usage of Terminal 2E
and the new regional terminal T2G located east of S3 which will improve connections).
There are also substantial efficiency and cost savings associated with the
concentration on the linked 2C, 2F, 2E, S3 and T2G terminal complex by mid-2008.
Total passenger handling capacity of the combined Air France-KLM/SkyTeam terminal
area complex will be more than 38m in 2008, compared to a design capacity of 30m at
Heathrow T5 for BA, i.e. a similar dedicated terminal area but constructed around a
more dispersed number of gates/satellites designed to accommodate connecting traffic
to the main long-haul base at 2E/S3 and thus the maximum number of contact stands.
Terminal 2C has a current passenger handling capacity of 4m, 2F 10m passengers, 2E
13m (from 6m currently), S3 is able to handle 8.5m passengers and the regional
terminal 2G has a 3m passenger handling capacity. Terminal T4, which is planned to
be constructed to the East of Terminal 2E will add a further 25m passenger capacity
after 2014 taking the total SkyTeam dedicated area to passenger capacity of 63.5m.
Fuel costs: hedging continues to contain costs
Air France-KLM is one of the best hedged airlines in Europe and benefits from the
decision to replace a large part of the long-haul fleet earlier than its peers.
Table 19: Fuel hedging and cost profile
Component
07/08e
08/09e
09/10e
10/11e
Brent (USD/barrel)
Jet fuel new CIF (USD/ton)
Consumption (000 m3)
% of consumption hedged
Average hedge price (USD/ton)
Final cost (USD/barrel)
Cost before hedge (USDbn)
Cost after hedge (USDbn)
81
791
11,573
78
61
66
7.5
6.4
88
855
11,983
67
60
69
8.5
7.1
84
820
12,456
51
67
75
8.5
7.8
82
801
12,813
31
68
78
8.6
8.2
Note: data are at 9 November 2007
Source: Company, Exane BNP Paribas estimates
This will continue going forward, since hedge positions are increased opportunistically
when the crude price dips and thus we are looking at dynamic and not static positions.
The latest fuel hedge figures show that Air France-KLM is 78% hedged for the current
year at an average hedge price of USD61/bbl (final price of USD66/bbl). However, we
are at very early days in respect of hedging cover and the company will
opportunistically add to the positions on any oil price weakness. We estimate that fuel
expenses should rise from USD6.3bn reported in 2006/07 to USD6.4bn (+8%) in
2007/08 and USD7.1bn (+9%) in 2008/09, all at around USD81/bbl Brent crude
equivalent. This remains one of the best levels of hedge cover among the European
airlines and the hedged fuel cost estimates are already in our forecasts. Fuel
consumption per passenger is also significantly reduced because of the fleet upgrades
in the past few years, focused in the long-haul segment, mainly on the introduction of
B777-300s.
41 Air France-KLM
Also offsetting the additional fuel costs are the merger synergy effects, ongoing cost
cutting in each operating company and, in particular, the very powerful effect of high
average seat load factors on asset utilisation (at around 83–84%, Air France-KLM’s
average seat load factors are approximately 4–5 points higher than BA and 6 points
higher than Lufthansa – this needs to be adjusted for the higher proportion of short-haul
aircraft in Lufthansa’s fleet but the difference with BA is marked, since BA has a
proportionately higher long-haul fleet although it is significantly smaller than Air FranceKLM in terms of actual aircraft numbers). Air France-KLM also benefits strongly from
the weakness of the US dollar.
New “Challenge 10” EUR1.4bn cost-cutting programme
Air France-KLM launched a new EUR1.4bn three-year cost-cutting programme,
Challenge 10, in May 2007. This programme is intended to reduce costs in targeted areas
(as shown in Chart 13 below) for a total amount of EUR1.4bn over a period of three
years. This includes EUR212m of identified cost synergies following the merger. The
objective is to reduce unit costs by 3% over the three-year period. We are confident that
this is achievable, since it builds upon the previous cost-savings programme and actions
to generate synergies from the merger.
Chart 13: Identified sources of cost savings
Fleet
24%
Processes/
productivity
49%
Marketing costs
7%
Purchases
20%
Source: Company
According to our estimates, it will account for approximately one percentage point of
EBIT margin improvement between now and conclusion of the programme in 2009/10.
In combination with the development of the route network, we believe the programme is
a core part of the programme to raise post-tax ROCE by a further two percentage
points to 8.5%.
Challenge 10 is expected to realise EUR560m of cost savings in the current year alone, with
EUR430m targeted for 2008/09 and EUR410m for 2009/10. 6% of this year’s targeted cost
reductions are expected to be trimmed from marketing costs, 27% from purchasing, 37%
from processes and productivity and 31% or EUR175m from reduced fleet cost.
Table 20: Challenge 10 Programme – cost-savings targets
EURm
Marketing costs
Purchasing
Processes/productivity
Fleet
Total
Cumulative
Source: Company, Exane BNP Paribas estimates
42 Air France-KLM
07/08e
08/09e
09/10e
35
150
200
175
560
560
20
60
250
100
430
990
45
70
230
65
410
1,400
Focus on productivity and process gains
A large part of the programme’s benefits are expected to be generated from
improvements in processes and productivity which will involve headcount reductions in
support areas which have been rendered redundant through new booking and check-in
technologies. The remainder (about 50%) are expected to be derived from reductions
in marketing and purchasing costs and more efficient fleet. This will be an important
driver of the ROCE improvements (8.5% post-tax targeted by 2009/10).
Over the whole three-year programme EUR680m of cost savings or 49% are expected
from processes and productivity (e.g. expansion of e-services at airports, reductions in
support functions and headcount, IT integration and integration of marketing teams
outside France and the Netherlands. The company is benefiting from the three-year
pay deals with employees after a one-off increase in national insurance costs in
2006/07, following the changes after privatisation (the UNEDIC increase). A three-year
pay deal agreed with the pilots in May 2006 gives an increase linked to inflation only.
Pay and productivity negotiations with cabin crew are expected to start in December.
The next largest item is fleet savings, which are expected to save EUR340m in costs.
This includes the accelerated replacement of 18 B747s by B777s giving savings in fuel
and maintenance costs. Procurement is expected to save EUR280m and marketing
costs, EUR100m.
Productivity gains of 4% p.a. in the next 3 years
The goal is to reduce unit costs by 3% over three years and achieve productivity gains
of 4% per annum over the next three years. Based on the progress already made
following the merger in 2004, since when the number of equivalent full-time employees
has risen by only 2% and production (capacity in EASKs) has risen by around 35%, we
believe these targets are achievable. The key is technology (IT, aircraft and airport
infrastructure) allowing better organisation of business processes and procedures
against a background of growing passenger volumes.
Synergy benefits from the merger are expected to continue but the EUR212m cost
synergies expected to be generated between the beginning of April 2007 and the end
of March 2009 are expected to be subsumed in the Challenge 10 cost-savings targets
since, correctly in our view, costs for each organisation become more difficult to
segregate as the accounting systems are integrated. Revenue synergies can continue
to be identified, taking the revenue synergies from 01/04/07 to 31/03/09 to EUR128m
and EUR135m for the following two years. If this is achieved, it will take the total
synergies achieved by the merger to EUR1bn (EUR443m from revenue synergies and
EUR557m from cost synergies). This compares with a range for total synergies given at
the time of the merger announcement of EUR385m to EUR495m in 2008/09. In our
view, the continuous upgrading of synergies and their positive impact on margins
demonstrates convincingly the benefits to be derived from further industry
consolidation.
43 Air France-KLM
Strong FCF leading to net debt reduction
The higher levels of profitability and strong cash generation have had a positive effect on
the group’s balance sheet, which is now the second strongest after Lufthansa among the
network airlines and with a better FCF perspective than either Lufthansa or BA.
Balance sheet strengthened
The balance sheet has been strengthened considerably following the higher level of
profitability and strong free cash flow. This positions Air France-KLM to take advantage of
a multitude of profitable investments (e.g. joint ventures in growth markets) going forward.
The dividend payout will rise but there is unlikely to be a share buyback or significant hike
in the payout ratio. FCF is set to rise strongly in the next few years, with the delays in
A380 delivery having a further positive effect in terms of lower capex and thus higher FCF
but a lost opportunity in terms of unit cost reductions in 2007/08. Fleet capex is projected
to remain relatively stable at EUR1bn to EUR1.2bn p.a. over the period until 2009/10
rising to EUR1.5bn p.a. thereafter.
Capex growth remains modest
Estimated capital expenditure is shown in the chart below. Capital expenditure on the
fleet peaked in 2005/06, as the group used part of the proceeds of the Amadeus GDS
leveraged buyout to accelerate fleet replacement. Air France-KLM retains a 22%
interest in the WAM buyout vehicle.
Chart 14: Estimated capital expenditure
3.0
2.5
EURbn
2.0
1.3
1.0
1.2
1.0
1.3
1.2
1.2
1.1
FY06/07
FY07/08e
FY08/09e
1.1
1.0
1.5
1.5
1.5
FY09/10e
FY10/11e
FY11/12e
1.5
1.0
1.5
0.5
0.0
FY05/06
Fleet
Other Investments
Source: Company, Exane BNP Paribas estimates
In order to improve cost efficiencies as well as to cater for anticipated long-haul
demand, notably from China and India, Air France-KLM is acquiring 18 B777-300ER
aircraft (joining an existing fleet of 44 B777 type aircraft in the Air France fleet and 14 in
the KLM fleet) over the period 2007–2013. These are replacing 18 older B747 aircraft
which are no longer efficient in terms of capacity and fuel cost on certain routes and 5
cargo aircraft. The company is also converting 2 options on A380 aircraft to firm orders,
taking the total number of firm orders to 12. Thirty new orders have also been placed
for A320 and A321 aircraft, 19 as replacement aircraft and 11 as additions to the
medium-haul fleet of Air France, which is growing less rapidly than the long-haul fleet.
In 2008, discussions are expected to start on choice of either the A350 or the B787 for
44 Air France-KLM
the new medium-haul aircraft to be delivered after 2015, with joint Air France and KLM
fleet procurement of a single aircraft type.
We expect that fleet capital expenditure will decline in 2008/09 before growing again to
EUR1.5bn in 2009/10e. Approximately half of capital expenditure is on fleet
replacement and the remainder represents ground investments, capitalised
maintenance costs and spare parts and supplies (part of which are used in the
maintenance activity).
Free cash flow should continue to grow
Reported free cash flow (which includes aircraft disposals) rose to EUR632m in
2006/07 from EUR339m in 2005/06 (the year of peak capex at EUR2,544m). The
operating cash flow margin remained stable a 12.5% but with lower capex, gearing fell
further. EBITDAR/net financial costs rose from 13.8x in 2005/06 to 32.6x in 2006/07.
Based on our projections, Air France-KLM still continues to generate strongly positive
FCF. The main reason for this is the strong cost savings and efficiencies generated by
the new aircraft which help to keep the FCF margin, which is already the highest
among the network airlines, at a high level.
Financial leverage continues to fall
Gearing (net debt excluding capitalised operating leases to equity) fell from 1.20x at the
time of the merger to 0.43x in 2006/07 and 0.37x at the end of June 2007.
Chart 15: Progress in reducing financial leverage
6.0
1.0
0.9
0.8
0.7
4.0
0.6
3.0
0.5
0.4
2.0
Gearing (x)
Net debt (EURbn)
5.0
0.3
0.2
1.0
0.1
0.0
0.0
FY04/05
FY05/06
FY06/07
30/06/2007
Source: Company
Including operating lease payments capitalised at 7x, adjusted gearing fell from 1.12x
in 2005/06 to 0.93x in 2006/07. The sharp reduction in gearing gives Air France-KLM
considerable scope to participate in consolidation using existing credit resources,
particularly since fleet capex has peaked and is tracking at the more modest level of
around EUR1bn or approximately 35% of net cash flow from operating activities.
45 Air France-KLM
Dividend outlook should mirror earnings growth
We expect Air France-KLM to continue to maintain a progressive dividend policy in line
with the development of net income. Our dividend estimate for 2007/08 is EUR0.54, for
2008/09 EUR0.64 and for 2009/10, EUR0.74, representing a payout ratio of around
15% and a current yield of approximately 3%. In our view, there is the possibility of a
higher dividend in 2007/08 based on the proceeds of the WAM capital restructuring but
we have not yet factored this into our estimates.
46 Air France-KLM
Glossary
RPK
Revenue Passenger Kilometres: passenger traffic. RPK = number
of fare-paying passengers x distance flown
ASK
Available Seat Kilometres: passenger capacity. ASK = number of
seats offered x distance flown
RTK
Revenue Tonne Kilometres: total traffic (passenger and cargo)
ATK
Available Tonne Kilometres: total offered capacity (passenger and
cargo)
CTK
Cargo Tonne Kilometres: total cargo traffic
ATM
Air Transport Movement
AEA
Association of European Airlines
Passenger Load Factor (%)
Utilisation of passenger capacity. Load factor = RPK/ASK
Breakeven Load Factor (%)
The proportion of capacity that must be filled at the average yield in
order to cover costs
Yield
Passenger revenue per RPK or total revenue per RTK or ATK
Unit cost
Operating cost per ASK or ATK
Productivity
ATKs per MPE
MPE
Manpower equivalent (number of full-time equivalent employees)
Source: Exane BNP Paribas from industry data
47 Air France-KLM
Rating definitions
Stock Rating (vs Sector)
Outperform: The stock is expected to outperform the industry large-cap coverage universe over a 12-month investment horizon.
Neutral: The stock is expected to perform in line with the industry large-cap coverage universe over a 12-month investment horizon.
Underperform: The stock is expected to underperform the industry large-cap coverage universe over a 12-month investment horizon.
Sector Rating (vs Market)
Outperform: The sector is expected to outperform the DJ STOXX50 over a 12-month investment horizon.
Neutral: The sector is expected to perform in line with the DJ STOXX50 over a 12-month investment horizon.
Underperform: The sector is expected to underperform the DJ STOXX50 over a 12-month investment horizon.
Key ideas
BUY: The stock is expected to deliver an absolute return in excess of 30% over the next two years. Exane BNP Paribas’ Key Ideas Buy List comprises selected stocks that
meet this criterion.
Distribution of Exane BNP Paribas’ equity recommendations
As at 10/10/2007 Exane BNP Paribas covered 424 stocks. The stocks that, for regulatory reasons, are not accorded a rating by Exane BNP Paribas are excluded from
these statistics. For regulatory reasons, our ratings of Outperform, Neutral and Underperform correspond respectively to Buy, Hold and Sell; the underlying signification
is, however, different as our ratings are relative to the sector.
43% of stocks covered by Exane BNP Paribas were rated Outperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 4% of stocks with
this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 12% of the companies
accorded this rating*.
39% of stocks covered by Exane BNP Paribas were rated Neutral. During the last 12 months, Exane acted as distributor for BNP Paribas on the 5% of stocks with this
rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 11% of the companies
accorded this rating*.
18% of stocks covered by Exane BNP Paribas were rated Underperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 1% of stocks
with this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 7% of the
companies accorded this rating*.
* Exane is independent from BNP Paribas. Nevertheless, in order to maintain absolute transparency, we include in this category transactions carried out by BNP
Paribas independently from Exane. For the purpose of clarity, we have excluded fixed income transactions carried out by BNP Paribas.
Air France-KLM – historical closing price & target price (as of 19/11/2007)
EUR60.00
EUR50.00
EUR40.00
EUR30.00
EUR20.00
EUR10.00
EUR0.00
11-04
02-05 05-05 08-05
11-05
02-06 05-06 08-06
Clo sing price
Date
13/08/2007
29/05/2007
16/02/2007
03/11/2006
04/09/2006
20/02/2006
06/12/2005
23/05/2005
Closing price
EUR28.56
EUR36.82
EUR35.59
EUR28.12
EUR21.65
EUR19.64
EUR16.87
EUR13.00
Source: Exane BNP Paribas
48 Air France-KLM
Target price
EUR46
EUR48
EUR41.2
EUR37
EUR27.5
EUR25.8
EUR22.8
EUR17.5
11-06
02-07 05-07 08-07
Target price
Rating
Outperform
Outperform
Outperform
Outperform
Outperform
Outperform
Outperform
Outperform
Changes
Target price
Target price
Target price
Target price
Target price
Target price
Target price
Target price
Commitment of transparency on potential conflicts of interest
Complete disclosures, please see www.exane.com/compliance
Exane
Pursuant to Directive 2003/125/CE and NASD Rule 2711(h)
Questions
Answers
1. Investment banking and/or Distribution
- Has Exane managed or co-managed in the past 12 months a public offering of securities for the subject company/ies?
- Has Exane been acting as distributor for BNP Paribas, when BNP Paribas managed or co-managed in the past 12 months
a public offering of securities for the subject company/ies
- Has Exane received compensation for investment banking services from the subject company/ies in the past 12 months or
expects to receive or intends to seek compensation for investment banking services from the subject company/ies in the
next 3 months?
NO
NO
NO
2. Liquidity provider agreement and market-making
- At the date of distribution of this report, does Exane act as a market maker or has Exane signed a liquidity provider
agreement with the subject company/ies?
NO
3. Corporate links
- Does the research analyst principally responsible for the preparation of this report or a member of his/her household serve
as an officer, director or advisory board member of the subject company/ies.
4. Analyst's personal interest
- Does the research analyst principally responsible for the preparation of this report own a financial interest in the subject
company/ies?
NO
NO
5. Significant equity stake
- Does Exane own 1% or more of any class of common equity securities of the subject company/ies as of the end of the
month immediately preceding the date of publication of the research report or the end of the second most recent month if
the publication date is less than 10 calendar days after the end of the most recent month?
- Does Exane own a stable shareholding in the subject company, above the legal threshold defined in article L 233-7 of the
French Commercial Code?
NO
NO
6. Disclosure to Company
- Has a copy of this report; with the target price and/or rating removed, been presented to the subject company/ies prior to
its distribution, for the sole purpose of verifying the accuracy of factual statements?
YES
- Has this report been amended following this disclosure to the company/ies and prior to its distribution?
NO
7. Additional material conflicts
- Is Exane aware of any additional material conflicts of interest with regard to the distribution of the research?
NO
Source: Exane
BNP Paribas
Exane is independent of BNP Paribas (BNPP) and the agreement between the two companies is structured to guarantee the independence of
Exane's research, published under the brandname « Exane BNP Paribas ». Nevertheless, to respect a principle of transparency, we
separately identify potential conflicts of interest with BNPP regarding the company/(ies) covered by this research document.
Potential conflicts of interest: None.
Source: BNP Paribas
Note: This document was modified after its initial posting on our website to correct the following sentence on page 4. “Despite a recent recovery, the share price
remains 72% below its June peak of EUR39.4. Table 13 was replaced due to missing data in columns.
49 Air France-KLM
Air France-KLM
profile
Sector ratings
Rating
Business
Air France-KLM is the world's largest
international passenger airline with the
greatest number of destinations worldwide.
It has three main activities: passenger
transport (80% of revenues in 2006/07),
freight transport (13% of revenues) and
engineering and maintenance (4% of
revenues).
The group is also involved in leisure travel
(through Transavia), catering (Servair) and
has a 23% stake in the leveraged holding
company of Amadeus GDS.
Air France-KLM's strategy is based on the
profitable development of the airline
business. The focus is on long-haul flights
utilising the growth capacity of Paris-CDG
(Europe's number one hub) and Amsterdam
and also through links with the group's
SkyTeam alliance partners (Delta Airlines,
Continental, Northwest, Aeromexico, CSA,
Korean Air and Alitalia). The group is
generating, and has further scope for, a
significant improvement in asset utilisation
and margins through revenue and cost
synergies following the merger of Air France
and KLM in 2004.
Scheduled passenger revenues by
destination 2006/07
Africa/Middle
East
14%
►
(+)
75.1
(+)
22.9
(=) DKK63,100.0
(-)
324.3p
(=)
53.0
(+)
17.7
(=)
4.9
95.0
41.5
DKK76,000.0
408.0p
53.2
30.7
5.3
27
81
20
26
10.9
11.6
770.0p
3.1
23.1
9
114
33
(13)
5
Caribbean/
Indian
Ocean
7%
74
8
Midcaps (Priced at 19 November 2007)
Air Berlin
Austrian Airlines
easyJet
Iberia
SAVE
(-)
(+)
(+)
(-)
(=)
10.0
5.4
580.0p
3.6
22.1
Recent Exane publications
Date
Company
20 Nov. 2007
24 Oct. 2007
11 Oct. 2007
31 Jul. 2007
easyJet
Lufthansa
Type
Title
Report
Feedback from SMC forum: main
highlights
For business as well as pleasure
Trapped Value
Flight path set for Open Skies
Report
Report
Update
Date
Event
22 Nov. 2007
14 Feb. 2008
H1 2007 Results
Q3 2007 Results
North
America
16%
Latin
America
7%
Europe/
North Africa
28%
Operating profit by activity, 2006/07
Transavia/
Maintenance catering
5%
4%
Cargo
5%
Passenger
86%
Management
President and CEO
Jean-Cyril Spinetta
COO
Pierre-Henri Gourgeon
Investor Relations
Dominique Barbarin
French State
Treasury Stock
Free float
Upside/
(downside)
(%)
Diary
France
13%
Asia
15%
Shareholders (%)
Target price
(EUR)
Big caps (Priced at 19 November 2007)
Aéroports de Paris
Air France-KLM
AP Moller-Maersk
British Airways
Fraport
Lufthansa
Ryanair
►
Price
(EUR)
Stake
17.8
0.5
81.7
50 Air France-KLM
Pages
94
55
87
40
Price at 19/11/07: EUR 22.9
Target price: EUR 40.5 / + 76.7%
Stock rating vs Sector: Outperform
Sector rating vs Market: Outperform
Enterprise value (EURm)
14,487
50.0
Mkt cap. / Free float (EURm)
6,715 / 5,486
40.0
3m average volume (EURm)
69.83
12-mth high / low (EUR)
38.3 / 22.6
30.0
Performance
1mth
3mths 12mths
Absolute
(12%)
(17%)
(26%)
20.0
Rel. (Sector)
(1%)
(14%)
(26%)
Rel. (DJ STOXX50)
(6%)
(16%)
(24%)
Reuters/Bloomberg
AIRF.PA / AF FP
Analyst: Nick van den Brul
10.0
CAGR
1998/2007
2007/2009
6.8
EPS restated (*)
22%
10%
Price
2.8*CFPS
Relative to DJ STOXX50
CFPS
11%
2%
Mar. 98
Mar. 99
Mar. 00
Mar. 01
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
PER SHARE DATA (EUR)
No of shares year end, basic, (m)
195.428
198.483
219.781
219.781
219.781
219.781
219.781
269.384
269.384
284.415
Average no of shares, diluted, excl. treasury stocks (m)
194.443
196.372
200.462
218.515
217.688
217.269
216.909
288.957
293.138
293.138
EPS reported
1.72
1.27
1.77
1.93
0.70
0.55
0.43
6.61
3.47
3.32
EPS restated
1.31
0.59
1.03
2.04
0.55
0.96
0.89
2.71
2.18
3.03
% change
NS
(54.8%)
74.1%
97.2%
(73.2%)
75.1%
(7.1%)
205.2%
(19.8%)
39.1%
CFPS
4.84
4.06
5.52
4.72
4.22
5.79
5.02
6.24
7.09
9.54
Book value (BVPS) (a)
12.3
13.6
15.9
17.6
18.0
18.2
18.5
21.9
28.7
29.2
Net dividend
0.00
0.00
0.14
0.22
0.10
0.06
0.05
0.15
0.30
0.48
STOCKMARKET RATIOS
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
YEARLY AVERAGE PRICES for end Mar. 98 to Mar. 07
P / E (P/ EPS restated)
19.1x
30.1x
16.1x
9.9x
32.2x
13.4x
14.8x
5.0x
7.0x
8.3x
P / E relative to DJ STOXX50
104%
135%
77%
49%
134%
60%
93%
36%
53%
75%
P / CF
5.2x
4.4x
3.0x
4.3x
4.2x
2.2x
2.6x
2.2x
2.2x
2.6x
FCF yield
2.0%
(3.8%)
(0.8%)
(13.6%)
(10.6%)
(9.9%)
(3.4%)
(3.2%)
3.0%
6.9%
P / BVPS
2.04x
1.31x
1.05x
1.15x
0.98x
0.70x
0.71x
0.62x
0.53x
0.87x
Net yield
0.0%
0.0%
0.8%
1.1%
0.6%
0.5%
0.4%
1.1%
2.0%
1.9%
Payout
0.0%
0.0%
13.5%
10.7%
18.2%
6.3%
5.6%
5.5%
13.8%
15.9%
EV / Sales
1.00x
0.84x
0.69x
0.82x
0.81x
0.72x
0.69x
0.77x
0.67x
0.69x
EV / Restated EBITDA
6.4x
6.1x
4.9x
6.4x
6.1x
4.5x
4.6x
5.0x
4.0x
4.2x
EV / Restated EBIT
20.6x
25.4x
16.9x
22.5x
31.7x
22.1x
23.6x
14.9x
9.9x
10.1x
EV / OpFCF
31.6x
353.7x
121.2x
NC
NC
NC
438.7x
206.5x
45.0x
50.2x
EV / Capital employed (incl. gross goodwill)
1.2x
1.0x
0.9x
1.0x
0.9x
0.8x
0.8x
1.0x
0.9x
1.1x
ENTERPRISE VALUE (EURm)
9,236
7,601
7,088
10,019
10,101
9,153
8,470
14,693
14,292
15,824
Market cap
4,879
3,512
3,346
4,429
3,841
2,780
2,852
3,535
4,008
6,832
+ Adjusted net debt
4,110
3,839
3,833
5,758
6,352
6,558
5,759
11,592
10,621
9,353
+ Other liabilities and commitments
473
482
375
346
420
368
446
0
0
0
+ Revalued minority interests
41
30
21
29
28
23
16
66
66
66
- Revalued investments
266
261
487
543
540
576
604
500
404
428
P & L HIGHLIGHTS (EURm)
Mar. 01
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
Switch to IFRS data from FY ended 03/06
Sales
9,256
9,100
10,324
12,280
12,528
12,687
12,337
18,984
21,452
23,077
Restated EBITDA (b)
1,439
1,254
1,461
1,571
1,656
2,013
1,849
2,943
3,531
3,752
Depreciation
(991)
(955)
(1,042)
(1,126)
(1,337)
(1,599)
(1,489)
(1,958)
(2,081)
(2,182)
Restated EBIT (b) (*)
448
299
419
445
319
414
360
985
1,450
1,570
Reported operating profit (loss)
376
267
358
443
235
192
139
551
936
1,240
Net financial income (charges)
(161)
(31)
(31)
(41)
(88)
(81)
(55)
(230)
(255)
(115)
Affiliates
35
30
52
45
31
29
53
73
(23)
17
Other
(14)
(9)
(21)
(5)
(11)
(13)
(22)
1,436
519
(7)
Tax
53
(4)
(1)
45
5
13
(2)
(133)
(256)
(248)
Minorities
(3)
(4)
(3)
(4)
(3)
(4)
(5)
14
(8)
4
Goodwill amortisation
0
0
0
(62)
(16)
(16)
(15)
0
Net attributable profit reported
286
249
354
421
153
120
93
1,711
913
891
Net attributable profit restated (c)
255
117
207
384
103
192
178
784
638
888
Mar. 98
Mar. 99
Mar. 00
Mar. 01
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
CASH FLOW HIGHLIGHTS (EURm)
EBITDA (reported)
1,367
1,222
1,400
1,570
1,572
1,791
1,628
2,508
3,017
3,422
EBITDA adjustment (b)
72
32
61
2
84
222
221
434
514
330
Other items
(290)
(273)
(252)
(427)
(562)
(614)
(615)
(952)
(1,231)
(1,119)
Change in WCR
23
70
91
232
97
(150)
54
212
562
60
Operating cash flow
1,172
1,050
1,300
1,377
1,191
1,249
1,288
2,202
2,862
2,693
Capex
(879)
(1,029)
(1,242)
(1,882)
(1,448)
(1,410)
(1,269)
(2,131)
(2,544)
(2,378)
Operating free cash flow (OpFCF)
293
21
58
(505)
(257)
(161)
19
71
318
315
Net financial items + tax paid
(196)
(156)
(87)
(103)
(152)
(117)
(118)
(186)
(196)
163
Free cash flow
96
(134)
(29)
(608)
(409)
(278)
(99)
(115)
122
478
Net financial investments
141
393
32
241
486
319
405
(3,652)
727
509
Other
0
(70)
3
(476)
(50)
26
61
(752)
98
190
Capital increase (decrease)
0
0
244
0
1
5
0
(33)
0
0
Dividends paid
(1)
(1)
(6)
(38)
(66)
(34)
(24)
(24)
(41)
(88)
Increase (decrease) in net financial debt
(237)
(187)
(244)
881
38
(38)
(343)
4,576
(906)
(1,089)
Cash flow, group share
941
798
1,106
1,032
919
1,258
1,088
1,804
2,078
2,796
BALANCE SHEET HIGHLIGHTS (EURm)
Mar. 98
Mar. 99
Mar. 00
Mar. 01
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
Fixed operating assets, incl. gross goodwill
6,555
6,649
7,185
8,628
8,906
8,778
8,515
12,931
13,608
14,186
WCR
(587)
(666)
(855)
(1,100)
(1,268)
(984)
(1,058)
(2,056)
(2,246)
(3,755)
Capital employed, incl. gross goodwill
5,968
5,983
6,330
7,528
7,638
7,794
7,457
10,875
11,362
10,431
Shareholders' funds, group share
2,407
2,704
3,485
3,874
3,961
3,994
4,062
5,909
7,734
8,299
Minorities
20
23
22
25
29
33
23
111
119
113
Provisions/ Other liabilities
1,198
1,076
1,093
994
937
1,095
1,039
1,640
1,645
1,612
Net financial debt (cash)
2,465
2,278
2,034
2,915
2,953
2,915
2,572
7,148
6,242
5,153
FINANCIAL RATIOS (%)
Mar. 98
Mar. 99
Mar. 00
Mar. 01
Mar. 02
Mar. 03
Mar. 04
Mar. 05
Mar. 06
Mar. 07
Sales (% change)
NS
(1.7%)
13.5%
18.9%
2.0%
1.3%
(2.8%)
53.9%
13.0%
7.6%
Organic sales growth
Restated EBIT (% change) (*)
NS
(33.2%)
39.9%
6.2%
(28.3%)
29.8%
(13.1%)
173.8%
47.3%
8.3%
Restated attributable net profit (% change) (*)
NS
(54.3%)
77.8%
114.9%
(73.3%)
74.7%
(7.3%)
306.5%
(18.7%)
39.1%
Personnel costs / Sales
30.2%
32.5%
30.0%
28.0%
29.8%
30.4%
33.1%
31.6%
29.6%
29.0%
Restated EBITDA margin
15.5%
13.8%
14.2%
12.8%
13.2%
15.9%
15.0%
15.5%
16.5%
16.3%
Restated EBIT margin
4.8%
3.3%
4.1%
3.6%
2.5%
3.3%
2.9%
5.2%
6.8%
6.8%
Tax rate
NC
1.6%
0.3%
NC
NC
NC
1.7%
7.8%
21.3%
22.2%
Net margin
3.1%
2.8%
3.5%
3.5%
1.2%
1.0%
0.8%
8.9%
4.3%
3.8%
Capex / Sales
9.5%
11.3%
12.0%
15.3%
11.6%
11.1%
10.3%
11.2%
11.9%
10.3%
OpFCF / Sales
3.2%
0.2%
0.6%
(4.1%)
(2.1%)
(1.3%)
0.2%
0.4%
1.5%
1.4%
WCR / Sales
(6.3%)
(7.3%)
(8.3%)
(9.0%)
(10.1%)
(7.8%)
(8.6%)
(10.8%)
(10.5%)
(16.3%)
Capital employed (excl. gross goodwill) / Sales
78.2%
78.6%
74.6%
79.8%
83.4%
85.4%
81.5%
75.8%
70.8%
60.7%
ROE (before goodwill)
10.6%
4.3%
6.0%
11.5%
3.0%
5.2%
4.8%
13.3%
8.2%
10.7%
Gearing
169%
141%
109%
148%
159%
163%
141%
193%
135%
111%
EBITDA / Financial charges
8.5x
10.0x
14.8x
11.5x
14.8x
23.7x
30.8x
13.3x
15.8x
26.8x
Adjusted financial debt / EBITDA
2.9x
3.1x
2.6x
3.7x
3.8x
3.3x
3.1x
3.9x
3.0x
2.5x
ROCE, excl. gross goodwill
6.2%
4.1%
5.4%
4.5%
3.1%
3.8%
3.5%
6.3%
7.5%
7.3%
ROCE, incl. gross goodwill
5.9%
3.9%
5.1%
4.3%
2.9%
3.6%
3.3%
6.0%
7.2%
7.0%
WACC
9.9%
10.1%
8.4%
8.3%
8.3%
7.7%
7.6%
6.7%
5.8%
6.6%
Average number of employees
46,385
48,921
52,213
55,777
59,296
71,525
71,654
102,077
102,422
103,050
(a) Intangibles: EUR628.00m, or EUR2 per share.
(b) adjusted for capital gains/losses, impairment charges, exceptional restructuring charges, capitalized R&D, pension charge replaced by service cost
(c) adj.for capital gains losses, imp.charges, capitalized R&D, exceptional restructuring , (*) also adjusted for goodwill for pre IFRS years
51 Air France-KLM
AIR FRANCE-KLM
Transport - France
Target Price
Mar. 08e
299.446
293.138
4.70
3.68
21.4%
10.41
33.0
0.54
Mar. 08e
6.2x
57%
2.2x
13.0%
0.69x
2.4%
14.8%
0.60x
3.6x
8.1x
13.8x
1.0x
14,487
6,715
8,104
0
66
398
Mar. 08e
24,110
3,981
(2,194)
1,787
1,450
(137)
17
315
(246)
(4)
1,395
1,078
Mar. 08e
3,644
337
(751)
20
3,250
(2,200)
1,050
(168)
882
322
0
300
(108)
(1,396)
3,051
Mar. 08e
14,284
(3,775)
10,509
9,886
117
1,665
3,757
Mar. 08e
4.5%
Mar. 09e
299.446
293.138
4.24
4.36
18.6%
10.52
36.8
0.64
Mar. 09e
5.3x
51%
2.2x
7.6%
0.62x
2.8%
14.6%
0.57x
3.3x
6.9x
14.7x
0.9x
14,375
6,715
7,992
0
66
398
Mar. 09e
25,403
4,347
(2,265)
2,082
1,733
(139)
17
(7)
(326)
(4)
1,274
1,278
Mar. 09e
3,998
349
(788)
(110)
3,449
(2,471)
978
(465)
513
0
0
0
(140)
(373)
3,084
Mar. 09e
14,929
(3,665)
11,264
11,020
121
1,655
3,384
Mar. 09e
5.4%
Mar. 10e
299.446
293.138
4.35
4.46
2.2%
10.81
40.7
0.74
Mar. 10e
5.1x
54%
2.1x
3.5%
0.56x
3.2%
16.7%
0.54x
3.1x
6.3x
16.7x
0.8x
14,413
6,715
8,030
0
66
398
Mar. 10e
26,813
4,608
(2,330)
2,278
1,922
(146)
17
(7)
(476)
(4)
1,306
1,306
Mar. 10e
4,252
356
(808)
(150)
3,650
(2,788)
862
(622)
240
0
0
0
(140)
(100)
3,168
Mar. 10e
15,839
(3,515)
12,324
12,186
125
1,645
3,284
Mar. 10e
5.6%
13.8%
21.4%
28.9%
16.5%
7.4%
18.8%
5.8%
9.1%
4.4%
(15.7%)
58.5%
10.9%
81%
29.0x
2.0x
8.2%
7.8%
7.2%
16.5%
18.6%
28.5%
17.1%
8.2%
20.6%
5.0%
9.7%
3.9%
(14.4%)
58.6%
11.6%
72%
31.4x
1.8x
9.1%
8.5%
7.2%
9.4%
2.2%
27.9%
17.2%
8.5%
26.9%
4.9%
10.4%
3.2%
(13.1%)
59.6%
10.7%
65%
31.7x
1.7x
9.3%
8.7%
7.2%
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