My first reaction, on reading yesterday that US Airways and the private equity group TPG were looking at making a joint bid for American Airlines, was why on earth would anyone want to do that?
Private equity companies are sufficiently vainglorious and convinced of their own invincibility that they are prepared to queue up for the most terminally moribund business.
But you would think US Airways would know better. Airlines have been among the worst investments over the long term. The graphs show our three quoted companies’ performance over the past five years, and it has not been pretty.
And the position for the biggest, International Consolidated Airlines Group, for some reason known by the acronym IAG and the consequence of the 2010 merger of British Airways and Iberia, is actually worse than it looks. The shares are approaching the 125p at which BA was floated in 1987.
I cannot think, offhand, of a worse-performing investment over that time. A sum of 125p invested in the FTSE 100 Index in 1987 would today, even in these markets, be worth about 388p; 125p in BA would be worth, as of last night, 141¾p.
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Airlines are poor investments because they have huge amounts of capital tied up in chunks of metal that are hostages to cyclical economic trends. They are also at the mercy of rising oil — and so fuel — costs.
They can be knocked sideways by unforeseen events, such as a cloud of ash from a volcano that no one has heard of before or terrorism. Historically there have been more airlines than the market could support because nationalistic amour propre required even the tiniest of countries to have its own. Then there has been the emergence of low-cost airlines that undercut the big carriers.
So someone once worked out that BA, as was, used to lose 40p in the bad years for every £1 it made in the good ones. But there are signs that the picture may be improving. Some of the national carriers have gone. In an aviational anschluss, Lufthansa took over Austrian Airlines. Sabena, of Belgium, surely a country that never needed an airline, went bust amid much acrimony in 2001.
BA bought Iberia with the intention of rationalising a business that was notoriously inefficient and eliminating €100 million of losses annually. Any US Airways-American Airlines link, though delayed by the latter’s bankruptcy protection, would have a similar rationale.
Douglas McNeill, an analyst at Charles Stanley, says: “There is a great deal of consolidation going on, and that will improve basic returns for equity providers in future.” Investing in the Spanish economy in 2010 does not look the greatest of calls, but only 13 per cent of IAG’s turnover last year came directly from Spain.
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IAG is also busy consolidating bmi, the budget airline bought from Lufthansa in April. This was a disaster for the German airline, pushing it into a small loss. Some analysts, including Mr McNeill who has a “buy” recommendation on the stock, believe the market is underestimating the gains that could flow if IAG gets right the restructuring of both Iberia, where it wants to focus more on regional flights through the Iberia Express low-cost venture launched in March, and bmi.
Other factors worry the market. One is the future of the oneworld global alliance of airlines, to which BA and Iberia belong. The second is the future of the IAG shares owned by the stricken Spanish bank Bankia. This represents about 12 per cent of the company and will have to be sold in due course.
This overhang has dragged down the IAG share price in recent weeks. A note this week from the analysts at UBS said that the 23 per cent fall in IAG shares over the previous month was down, in part, to fears that the Spanish bank could be forced to place the shares in the market at a thumping discount at a time when “the appetite by the market to invest in European aviation is low”.
This looks like something of an understatement. But UBS thinks the fall is overdone — the Bankia stake is worth a little more than £300 million, but almost twice this has come off IAG’s market worth over that previous month.
This leaves the low-cost carriers easyJet and Ryanair, whose chief executive, Michael O’Leary, is something of the sector’s court jester, never short of an eye-catching quote. As Mr McNeill at Charles Stanley points out, we tend to think of these as the battling underdogs, but they now have substantial fleets running into hundreds of craft.
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The problem is where they go now for further growth. EasyJet has been moving upmarket, aiming at the business traveller and trying out a policy of allowing customers to book seats. But it is tempting to conclude that the budget European market is now mature, with few obvious new destinations to bolt on.
Any expansion, at easyJet at least, has been complicated by the churning row with its founder Sir Stelios Haji-Iannou, who wants the company to remain its present size and concentrate on raising the dividend. Until the company’s future direction is clearer, the shares are for avoiding. But gamblers might note that in the past, as IAG’s shares have approached that flotation price, they have tended to bounce.
Gilts
Benchmark Government bonds in the UK and Germany were yielding less than ever. Investors, hungry for safer assets, were further unsettled by disappointing manufacturing surveys in China, Britain and across the eurozone, and by dismal American jobs numbers. They sent the yield on ten-year gilts eight more basis points lower to a mere 1.50 per cent.
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Bet of the day
Although oil prices suffered their biggest monthly fall since 2008 in May, spread-betters were still selling in June. Punters reasoned that a strong dollar and contracting manufacturing in China, Europe and Britain meant that demand for commodities was likely to wilt. Spreadex offered $83.46 to $83.52 on its Light Crude, Daily July contract.
Deal of the day
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WANDisco showed some fancy footwork on its AIM debut. Shares placed at 180p by Panmure Gordon, which could have sold them three times over, ran to 199p. The Sheffield company, valued at nearly £41 million, supplies software to allow computer programmers working on big projects from disparate locations to collaborate more easily.