After four summers marred by disruption, British Airways could be facing a winter of discontent, says Simon Wilson. So are BA shares set to plummet?
Is British Airways struggling?
Not as far as the stockmarket is concerned. In recent years, BA (LON:BAY) has been an excellent buy for the 231,000 private investors who own its shares. Those who bought as aviation was suffering in the wake of the September 11th terrorist attacks have seen their investment grow more than fourfold. In the past year alone, the share price has surged roughly 50% from around 300p to about 450p, and earlier this month touched 465p, its highest level since 1999. But in the past fortnight several analysts have downgraded BA from ‘Buy’ to ‘Hold’. That’s partly due to a 27% fall in April-June pre-tax profits (to £176m), but it also reflects the immense challenges facing British Airways, Britain’s national carrier.
What are these challenges?
Stronger (and perhaps unfair) competition, rising costs and mounting security worries. BA may no longer be the ‘world’s favourite airline’, but it still makes most of its profits from long-haul flights, where travellers tend to be less price-sensitive; in fact, last week it sold its loss-making UK domestic arm, BA Connect, to budget carrier Flybe. But even in long-haul it faces increased competition – both from rich, state-subsidised Middle Eastern carriers, such as Dubai’s Emirates Airlines, and from ailing US giants like Delta, who enjoy the luxury of using Chapter 11 bankruptcy as a way of cutting costs.
And what about BA’s rising costs?
The high oil price has pushed BA’s 2006 fuel bill to £2bn, while the August terrorism scare at UK airports cost it £100m – not to mention the loss of custom to non-Heathrow based rivals, such as Air France-KLM and Lufthansa. Chief executive Willie Walsh, who celebrated one year in the job last month, also has to contend with an ongoing OFT and US Justice Department probe into alleged price-fixing on long-haul routes. And on top of this, he has had to fend off rumours that two Middle Eastern airlines are mulling a takeover bid.
Is there any truth in the British Airways bid rumours?
BA’s lucrative landing slots at Heathrow, the world’s busiest airport, make it an attractive target – but its status as a national carrier makes a successful takeover unlikely. In any case, bid fears are just a blip on the radar compared to BA’s biggest threat – its massive pensions liabilities, which Walsh says “puts the long-term viability of British Airways at risk”. He would like to focus fully on BA’s ‘Fit for 5’ drive – the transfer of its Heathrow operations to the new Terminal 5 in 2008, a move which could slash costs and boost profits. But instead, Walsh and his team are preoccupied with pensions.
What’s the problem?
BA simply cannot afford to pay its 45,000 existing staff the same generous pensions it gives its current pensioners. If it does, it will go bust. The airline’s current deficit is £2.1bn, more than double its size three years ago. It’s not Britain’s biggest company deficit – BT, Shell and RBS have bigger liabilities. But relative to the size of the group, BA’s pensions hole is the deepest, at 44% of its market value. As things stand, BA says it has to pay £500m into its fund this year, swallowing up most of last year’s pre-tax profits of £620m. That’s not a sustainable position for any company – certainly not one that wants to spend billions of pounds on new aircraft.
What does BA propose to do?
Make its staff work five years longer – raising the retirement age for its 2,500 pilots to 60 and cabin crew to 65. Crucially, it also wants to effectively cap pension contributions at current levels by limiting increases in pensionable pay to inflation. Walsh has a reputation as a tough negotiator from his last job as Aer Lingus boss, but he faces an extremely hard task in convincing his heavily unionised workforce to accept the new deal.
What’s the time scale?
Walsh wants to solve the pensions question once and for all as a precondition for spending £10bn on new aircraft and had set mid-November as the deadline for reaching a deal. But the unions – the T&G, GMB, Amicus and pilots’ union Balpa – say detailed talks have scarcely begun and that strike action could begin before Christmas. That’s bad news for BA, where smooth labour relations are vital: the high-spending business passengers it relies on expect superior service from happy staff.
Is there significant further upside in the BA share price?
YES
1 Willie Walsh is a high-quality leader with a firm grip on all the issues facing BA.
2 The ‘Fit for 5’ programme will create huge efficiency savings in the next few years, transforming BA’s operations and prospects.
3 BA’s growing focus on high-end, long-haul travel will grow profits in the long term.
NO
1 All the potential good news is already priced into the current share price.
2 The BA pensions deficit problem cannot be solved quickly; the funding gap makes BA uncompetitive and threatens its future.
3 Fresh labour relations trouble will damage BA’s image and, more importantly, its bottom line.
If you would like to read about the airline sector as a whole, read: A bad year for airlines – but don’t ditch your stocks