Air France-KLM: Don't Expect Full Recovery In The Next Couple Of Years

Summary

• In Q2, Air France–KLM lost €2.6 billion.
• The distrust between the Dutch and French governments, the upcoming second wave of the pandemic in Europe, and the long recovery are making the airline uninvestable at this point.
• We stick to our recommendation that it’s better to avoid Air France–KLM, as there are better opportunities on the market with a more attractive risk/reward ratio.

Air France-KLM (OTCPK:AFRAF) (OTCPK:AFLYY) expects to recover from COVID-19 only in 2025. While liquidity is not a problem, since the airline received over €10 billion of state funds from France and Dutch governments, it's very unlikely that the company will be able to reward its shareholders anytime soon. With a high debt load, overleveraged balance sheet, and no profitability in sight, Air France-KLM's stock is likely going to trade in a distressed territory for a long time. The distrust between the Dutch and French governments, the upcoming second wave of the pandemic in Europe, and the long recovery are making the airline uninvestable at this point. We stick to our recommendation that it's better to avoid Air France-KLM, as there are better opportunities on the market with a more attractive risk/reward ratio.

From Bad to Worse

Before the pandemic Air France-KLM was already a poorly run airline. It wasn't able to achieve profitability on a constant basis and the never-ending rivalry between the French and Dutch governments, who are the biggest shareholders of the company, made it nearly impossible for Air France-KLM to become more efficient. After the purchase of a 14% stake of the airline by the Dutch government, the distrust between both governments widened and as a result, Air France-KLM will continue to be exposed to various political risks, which will hurt its bottom line.

The latest earnings results for Q2 showed how bad the situation inside the airline is. After grounding the majority of its fleet at the beginning of the year due to the pandemic, Air France-KLM suffered immense losses and in Q2 its revenues were down 83.2% Y/Y to €1.18 billion. The airline's traffic during the period was down 95.6% Y/Y to 1.2 million passengers, while its capacity was down 88% Y/Y. The airline's net loss was -€2.6 billion, which included a fleet impairment charge of €618 million due to the accelerated phasing out from the A380 program and a €105 million loss as a result of a bad oil hedging bet.

Source: Air France-KLM

Limited Growth

Going forward, it's unlikely that Air France-KLM will be able to create shareholder value anytime soon. Although the airline got a total of €10.4 billion in state aid from France and the Netherlands, the process of granting that state aid clearly showed the distrust of both countries to each other. For instance, when the Netherlands gave €3.4 billion in state aid, it provided the funds strictly to KLM. In exchange, it requires the airline to reduce its expenses at least by 15%, operate fewer flights during the night time to reduce noise pollution, and decrease its CO₂ emissions by 50% in the next decade. However, the most important part of the deal is giving access to its books to the Dutch state agent, who should ensure that the state funds are used strictly for KLM purposes and are not being wasted by Air France. The same is true for France, which gave a total of €7 billion in state aid strictly to Air France. It's safe to say that as long as there's going to be distrust between two biggest shareholders to each other, the airline's growth in the post-pandemic world will be limited.

In addition to political hurdles, COVID-19 will continue to hurt the airline's bottom line. The second wave of the pandemic already started in various countries of Europe and it will undoubtedly keep the air travel at distressed levels. Considering that the European Union decided to keep its borders closed and let only citizens of 12 countries to freely enter the Schengen area, it will take a long time for European air travel to return to its pre-COVID-19 levels. The updated forecast from IATA shows that air traffic will be able to return to its 2019 levels only in 2024. With that in mind, we believe that Air France-KLM is an airline with no growth perspectives and it's able to stay afloat only thanks to the European taxpayers' money.

At the end of June, Air France-KLM's total liquidity was €14.2 billion. At the same time, the airline has a net debt position of €7.97 billion and its TTM Net debt-to-EBITDA ratio at the end of June was 4.8x, an increase from 1.5x at the end of 2019. With a high debt load, overleveraged balance sheet, and no profitability in sight, Air France-KLM will continue to lose funds and use taxpayers' money just to stay alive. By the end of 2024, the airline expects to reduce its leverage ratio only to 3x, which is still a high multiple considering that there are already numerous companies that have a more attractive leverage ratio and better growth prospects.

For 2020 and 2021, Air France- KLM expects its capacity in comparison to 2019 to be down 40% and 20%, respectively. The airline also believes that it will be able to return to its pre-COVID-19 profitability levels only in 2025. At the same time, it will take a while for it to deleverage its books considering that Air France-KLM has worse operating and net margins than its peers. In addition, political hurdles will lead to numerous corporate governance issues that will make it hard for the airline to become more efficient than its competitors. For that reason, we don't expect Air France-KLM to fully recover anytime soon and believe that it's better to avoid the airline's stock since it's very unlikely that any shareholder value will be created anytime soon.

Source: Capital IQ

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.