2016 upgrades, last chance for reform
Our view: We lift 2015E profits 50% on a slightly better revenue outlook and a slight Q4-15E operating loss. With ~13% equity in the AFKLM EV this lifts our PT 25% to €8. We move to OP/SR on profit momentum but fundamental longer-term issues (productivity) remain to be solved. We see a last chance for reform: Failure risks likely underperformance reemerging after a ‘bumper’ Q3-16 summer.
Key points:
• AFKLM on track for almost Q4-15 break-even. Tiny unit revenue
upgrades and the windfall of still falling oil prices (but a weaker Euro)
sees 2015E operating profit lifted 50% to €637m underlying (2.5%
margin) and 2017E to ~€1bn (~4% margin). Note we include the adverse
€50m short-lived impact on bookings from the Paris terrorist attacks
(like Q1-15 and seen before elsewhere, e.g. Madrid, London).
• >70% upward BBG consensus revisions coming: BBG consensus at
€370m in 2015E (€733m in 2016) implies scope for large upward
profit revisions for in the next 3 months (Q3-14 due 18/02/2016). This
suggests scope for a strong (but speculative risk) upside performance
into 2016 amplified by the small (13%) equity component of EV.
• Big fundamental issues remain and 2016 is key: AFKLM has a relatively
unproductive workforce (Exhibits 4 and 5). Without fundamental
change, we see risk that 2017 profits sink YoY and the shares fall in 2017.
Without cost change, margin pressure will resume once fuel windfalls
wash through and are competed away (we see Europe awash with seat
overcapacity that compounds in 2017, in our view).
• No reform – no equity value: Without productivity reform we see
longer-term risk that higher costs leave the company fundamentally
unable to compete and ill-prepared to survive the next recession. If
ongoing decisions with unions do not yield progress in early 2016, then
fleet cuts are planned but this alone will not address the fundamental
productivity problem.
1. We see short-term upside into summer 2016 driven by large upward
consensus EPS revisions amplified by the high debt component of the
AFKLM EV. At a minimum we think investors should move to neutralise
any underweight positions.
2. More in Q1-2016? A successful Air France labour agreement in early
2016 could further lift this outlook. The risk is that an improving profit
backdrop makes progress harder.
3. We see risk that underperformance resumes after Q3-16 reporting
if the last chance at labour productivity reform is not grasped (and
GDP/demand outlook does not improve): After a potential bumper
summer 2016 profits we think investors (under our present scenario)
may then need to move to lock in any gains made by then – as without
deep change (which will be clear, or not, by end Q1-2016) the risk
of long-term nil equity value then will re-merge as fuel gain windfalls
wash out into 2017E.