Air France-KLM is talking to Apollo Global Management about raising funds to improve its balance sheet, in a deal that would involve spinning off its loyalty plan into a new entity. The disclosure came as the airline reported its latest quarterly financial results.
Benefitting from “very strong” revenue trends and significantly lower fuel costs, Air France-KLM reported Friday a solid 10% operating margin for this year’s April-to-June quarter. This follows a negative 5% operating margin in the offpeak January-to-March quarter, underscoring the seasonal variability that continues to challenge the company’s full-year margins. For the first six months of 2023 combined, operating margin was 3%.
The underwhelming first-half results also underscore the divergence in profitability between Air France-KLM and its U.S. partner Delta Air Lines, whose first-half operating margin was eight points higher, or 11%. More worrying, it highlights Air France-KLM’s chronic pattern of underperforming its peers, especially IAG, which also reported on Friday; IAG’s second quarter operating margin was 16%, bringing its half-year figure to 9%.
Air France-KLM, however, is making progress. Its 10% second quarter operating margin was about four points better than the 6% figure it posted in both the second quarter of 2022 and 2019. The improvement was driven by Air France’s business, which has started to outperform KLM. In the nearly two decades since Air France and KLM merged, the latter has routinely posted much stronger profits than the former. But that’s changing as KLM faces heightened operating difficulties at its Amsterdam Schiphol hub. It faced some fleet issues at its regional Cityhopper unit last quarter as well. Longer-term, KLM’s business model faces a significant threat from its own government, which is working to severely curtail the number of flights at Schiphol.
KLM in Amsterdam, more so than Air France in Paris, depends on connecting traffic, which in turn depends on network effects that could diminish as fewer flights are permitted. Some see Schiphol becoming more like hyper-congested London Heathrow, where demand has long outstripped handling capacity, compelling airlines to use larger aircraft. Amsterdam, however, generates much less origin and destination demand than London; in other words, travelers starting or ending their journeys there, not just flying there to connect.
The group also suffered as cargo revenues plummeted by a third year-over-year, and as its large maintenance business confronted labor shortages and supply chain disruptions, preventing it from capturing ample growth opportunities (there’s currently a worldwide shortage of aircraft maintenance capacity). Operating margin at the maintenance unit fell to 4%, from 6% in the same quarter a year ago. The group’s low-cost airline Transavia, meanwhile, which earned a double-digit operating margin in the spring quarter of 2019, dropped to break even this spring.
As the U.S. Big Three have made crystal clear, transatlantic demand has been red-hot this spring and summer, fueled by American tourists flying to Europe. Air France-KLM reported “very strong yield performance” on routes to Latin America as well, especially for close-in bookings typically made by business travelers. The group’s Asia capacity is still just two-thirds of what it was in 2019. Capacity is down on Caribbean and Indian Ocean routes as well. Africa is currently showing “strong traffic dynamics.” And on shorthaul routes within Europe and its periphery, yields are up but air traffic controller strikes are having an impact.
The current July-to-September quarter is typically Air France-KLM’s strongest. And bookings sure enough appear healthy, including those for Transavia. Operational reliability, management insists, is improving. Groupwide, capacity in ASK terms will be at about 95% of pre-pandemic levels in the second half of 2023. Unit costs for the year will be up in the low single digits, pressured by higher labor costs (including profit sharing). Fleet renewal and earlier headcount reductions should help with unit cost control longer-term. Over what management calls the “medium-term,” Air France-KLM is aiming for annual operating margins of 7-8%. For reference, it earned 4% in 2019. Make no mistake, though: 7-8% is nobody’s idea of great. A better adjective might be mediocre.
Along with its goal of boosting margins, the company is keen on improving its balance sheet. It has a new arrangement with the private equity giant Apollo to raise about $540 million. Apollo will lend the money to an Air France-KLM entity holding a pool of maintenance components, earning about 7% annual interest for three years and higher rates thereafter (the bonds Apollo will buy are perpetual, never maturing).
More interestingly, Air France-KLM is now in talks with Apollo about potentially raising another $1.6 billion, this time involving its Flying Blue loyalty plan. Apollo would receive regular fixed payments from a new entity with the right to issue and sell Flying Blue miles. But critically, the airline would retain full ownership rights to the valuable Flying Blue customer database. Airlines like Aeromexico, Air Canada, and Gol have in the past regretted selling their loyalty programs, in part because they lost control of their ability to market to members.
