Air France-KLM

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Air France-KLM is a global airline group, primarily focused on passenger transport, but also offering cargo services, and heavily reliant on its European network.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Air France-KLM is a Franco-Dutch airline group formed by the merger of Air France and KLM in 2004. The group operates a vast international network centered around its hub airports, Charles de Gaulle Airport in Paris, and Schiphol Airport in Amsterdam. It is structured into three main segments: passenger airline network, maintenance, and cargo operations.

Passenger Airline Network: This is the core segment for Air France-KLM, responsible for the majority of its revenue. It offers both long-haul international and short-haul regional flights.
The primary driver of profitability in this segment is the load factor, which represents the percentage of filled seats on each flight, and the yield, which reflects the revenue per passenger mile.
Maintenance: Air France-KLM has a significant maintenance division that not only services their own aircraft fleet but also offers third-party maintenance services.
Cargo: The cargo segment transports goods around the world, often combining passenger and cargo services.

Revenue Distribution: AFLYY’s revenue is heavily dependent on its passenger transport business, with a significant portion generated by transatlantic routes and within Europe. Regional differences are visible in its passenger revenues:

Asia: A very strong and long-term market for Air France KLM. It’s been recovering more slowly from the pandemic.
South America and Africa: Strong volume growth in these markets, with the highest average capacity.
North America: Consistently a very strong market with solid revenues.
Europe: This region provides a large amount of revenue, but is also where most of the competition lies.
In addition, their Cargo Operations account for a small fraction of their total revenue, and their maintenance operations also generate a small amount of revenue for the company.

Industry Trends: The airline industry is a highly competitive and cyclical sector, heavily influenced by factors such as fuel prices, economic conditions, and geopolitical events. Here’s a breakdown of recent and long term industry trends:

Post-Pandemic Recovery: The industry is still undergoing recovery from the COVID-19 pandemic, and there’s an increase in demand, which caused revenues to go up significantly, but capacity constraints in airplanes and airports are still an issue.
Fuel Prices: Fluctuations in fuel prices often greatly impact airline profitability.
Competition: Airline sector is highly competitive with various business models from low-cost carriers to network carriers, all fighting for similar passengers, and competition is even more fierce in Europe.
Technological Adaptations: Airlines are increasingly leveraging new technologies to improve efficiencies, as well as the customer experience.
Sustainability: Government regulations and pressure from passengers has made the industry pay greater attention to environmental issues and sustainability.
Rising Interest Rates: The era of cheap funding may be ending, and many players will see pressure from an increase in interest rates.
Capacity Growth: The capacity of airlines is limited by workforce and airplane manufacturing supply chain.

Margins: AFLYY’s margins are volatile given that they are significantly impacted by fuel prices and exchange rates.

Operating margins: For the years preceding 2023 the operating margins were very tight, but in 2023 and 2024 are much better, ranging from 5-10% on average.
Gross margins: Fluctuations in revenue and fuel prices can make these very volatile, but they have typically been above 20 percent.
Net profit margins: These have been more volatile, and dependent on many factors, most notably gains from disposals of certain assets.

Competitive Landscape: Air France-KLM operates in an industry where competition is extremely intense and highly fragmented.

The company competes against large airline groups such as Lufthansa and British Airways-Iberia, along with low-cost carriers such as Ryanair and easyJet in Europe. Also, in long-haul routes, they face competition from Middle Eastern carriers such as Emirates and Qatar Airways.
They also face competition from other modes of transportation.

What Makes the Company Different?

Strong brand recognition: As a legacy airline, they are well known and people tend to have loyalty to these established brands, creating some protection from smaller players, but this isn’t a very effective protection.
Extensive hub network: A well-connected network within Europe is a good foundation.

Financials in Depth Here are the financial results for the past 5 years: Revenues (in Millions of Euros) * 2018: 27,193 * 2019: 27,189 * 2020: 11,015 * 2021: 14,327 * 2022: 26,390 * Operating Profit (in Millions of Euros)* * 2018: 844 * 2019: 1136 * 2020: -6,369 * 2021: -3,169 * 2022: 1,229 Net Profit (in Millions of Euros) * 2018: 409 * 2019: -206 * 2020: -7,067 * 2021: -3,250 * 2022: 728 Debt (in Millions of Euros) * 2018: 11,007 * 2019: 12,075 * 2020: 17,732 * 2021: 20,513 * 2022: 17,756

Here are key findings:
*   **Volatility:** The pandemic hit the company hard, causing a 60% reduction in revenue. However, 2022 shows very strong recovery as people returned to the sky, causing almost a 100% increase in revenues.
*   **Operating Profitability:** Operating income also returned to profitability after the 2020 low.  
*   **Debt levels:** During the pandemic, their debt rose as they secured loans to survive, but it has not decreased much despite increased profits in 2022, so the balance sheet has still been negatively impacted by the pandemic.

Moat Analysis: Based on my analysis, I have rated AFLYY’s moat a 2 out of 5.

Weak brand loyalty: Airlines have difficulty generating brand loyalty, since the main thing passengers care about is price. For routes where price sensitivity is high, like in Europe, it is almost impossible to capture loyalty. For long-haul flights there is a slightly better possibility to have a loyal customer, but it’s still very weak.
Some switching costs: There is a degree of customer loyalty due to frequent flyer programs. These programs can be very important for frequent flyers, so there is some small switching cost involved for such customers.
Economies of scale in some airports: Some airlines with many destinations and slots at airports can create better profit margins due to better cost management, but this isn’t something truly unique to them.

Risks to the Moat and Business Resilience:

Fuel price fluctuations: As fuel prices fluctuate, it will greatly impact their overall profits, and this is a very big risk for airlines because they cannot control the price.
Intense competition: Airlines face constant price pressure from both low-cost and legacy carriers, especially in Europe. If they fail to adapt to this price competition they may lose their market share.
Economic sensitivity: Airline travel is directly tied to economic conditions, and recessions typically cause a fall in demand. * Geopolitical instability: Conflicts, pandemics, and changes in international regulations can severely disrupt air travel and reduce profitability.
Labor costs: Labor costs are a big part of airline expenses, and union strikes can reduce profitability and customer satisfaction.
High capital intensity: Airlines require huge capital expenditure for planes, maintenance, and airport facilities.

Understandability Rating I rate the company a 3 out of 5 for understandability. Airlines are complex businesses with multiple moving parts and different revenue sources and dependencies. Additionally, the numerous factors influencing their profitability can be hard to grasp, especially for people who are not familiar with how the airline industry works.

Balance Sheet Health Rating I rate the balance sheet a 2 out of 5. While the company’s revenues are on an upward trend, and profits are once again positive, they still carry a huge debt burden left over from COVID. Also, because of the capital-intensive nature of airlines, they always require high levels of debt, making the balance sheet less strong.

Recent Concerns:

In 2023 there were many operational disruptions, and issues with staffing and supply chains in multiple airports and airlines.
In November 2023, the company has made multiple agreements with pilots and unions, but there is always the possibility of these labor agreements not working out.
Increased concerns over the rise of low-cost airlines.
Some of their long-term financial performance goals, in the eyes of some analysts, are too optimistic given the high level of debt they are carrying.
They have a high debt to equity ratio, which can lead to them being in a vulnerable position if the industry sees another major downturn.

Management’s response: * Management has focused on cutting costs and increasing efficiency to compensate for the high fuel prices. * They also are trying to develop newer, more profitable routes in the growing markets in Asia, Africa, and South America.

They have acknowledged the debt issue as the main challenge that they need to address in the future.