ANALYSIS: IAG determined to tackle the pain in Spain

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One thing few people would doubt about International Airlines Group chief executive Willie Walsh is his willingness to tackle structural issues in the industry. Indeed speaking during an IAG investor day he pointed out the European airline industry would be better placed today if they had not left "legacy behaviour unchallenged" for so long.

The size of the next challenge for Walsh was made clearer as IAG detailed its deep restructuring plans for Spanish carrier Iberia. In contrast to the robust performance at British Airways, excluding costs related to the British Midland acquisition, Iberia's financial woes grew as economic difficulties in the country mounted. As highlighted in IAG's third quarter financial results, British Airways has made an €286 million ($365 million) operating profit since the beginning of the year, while Iberia has lost €262 million.

Under the restructuring Iberia plans to cut 4,500 jobs, 25 aircraft and 15% of capacity as part of a restructuring aimed at delivering a €600 million improvement in its operating profitability by 2015.

"We are determined to take Iberia from where it is today, which is clearly unsustainable, to where it needs to be," says Walsh, before reminding: "We [IAG] have a successful track record with implementing change in the industry." After pushing through reforms at British Airways, that reminder is probably not necessary.

"There have been losses of around €900 million [at Iberia] over the last four years. That is a lot of money and cannot go on," says Iberia chief executive Rafael Sánchez-Lozano. "It is clear we have to go through a very deep restructuring exercise."

What is also clear from both men is they are determined the restructuring will not be stalled. Iberia has set unions an end of January deadline to reach agreement on restructuring, but will go ahead on revamping the carrier with or without union support.

"We all win by an agreed solution. If there is no agreement, we will have to move to a non-agreed scenario," says Sánchez-Lozano, noting this would involve deeper cuts and heavier restructuring. "Today we can fund the plan. If we wait, we won't be able to do it. That is why we have a time pressure. We want to implement this fully for the summer season. We plan to be operating cash positive by mid-next year."

Under the restructuring Iberia will cut its capacity 15%, taking out 20 short-haul aircraft and five from the long-haul fleet. Details of the routes to be cut are yet to be revealed, but the company says the worst performing 13 routes contribute losses of €100 million. "We are going to focus on our core markets, that is why we are cutting 15% capacity," says Sánchez-Lozano.

"Our starting position with Iberia is what is our long-haul market?" says Walsh, noting this has involved identifying its strong natural markets. "We have cut long-haul that is not profitable and that will not be profitable even with these changes. The end result is a core long-haul network we believe is sustainable," he says.

Iberia long-haul route map (Nov 2012) 

 iberia long-haul network
 Source: Innovata Flightmaps Analytics

 

The short-haul network is then developed to support these long-haul routes. "Some of the short-haul network was feeding into short-haul, and we don't think that was sensible or sustainable."

The cuts will no doubt alert rivals, notably low-cost carriers like EasyJet and Ryanair. The latter's chief executive Michael O'Leary identified exactly this kind of retrenchment among European network carriers on short-haul routes as being central to driving Ryanair's own growth ambitions.

Iberia had already begun tackling the short-haul issues out of its Madrid base through the creation of Iberia Express. That came after the airline lost patience over efforts to negotiate on the cost base and brought with it industrial unrest.

"Iberia Express has been a fantastic success," says Walsh. "It went from decision to go in three months. It was profitable in its third month of operation. The cost base has been better than targeted. It's been a really strong performance and it demonstrates it can be done."

Its labour challenges though remain. A Spanish High Court overturned the original arbitration ruling that nominally ended the conflict between Iberia and its pilots over the creation of Iberia Express, essentially restarting the arbitration process.

"The positive is the arbitration ruling has been declared null and void," says Walsh. "We are working to fully understand the result of the court. But we are positive about the ruling."

IAG makes clear Iberia Express will continue and rules out any integration with the Barcelona-based low-cost carrier Vueling it already owns a stake in and is seeking full control of.

"The primary objective [of Iberia Express] is to feed the long-haul hub at Madrid and that remains the focus of Iberia Express," says Walsh. "We are not looking to integrate it with Vueling, which will be a standalone company with a focus primarily on Barcelona."

Vueling would give IAG a larger market share in Spain without compromising its network if the deal is completed - the cash offer for the remaining share will be made next year.

IAG launched Iberia Express in March this year with the objective of mainly addressing domestic routes as parent company Iberia builds on its connecting traffic at its Madrid-Barajas base.

Iberia Express now operates a total of 18 destinations with a 14-aircraft fleet. These include 13 domestic destinations and five international routes to Amsterdam, Dublin, Copenhagen, Dusseldorf and Frankfurt.

The launch of Iberia Express has not affected the operations of Iberia's other partners Air Nostrum and Vueling. While Iberia Express operates from its base Madrid-Barajas, Vueling has an operation with multiple bases, bypassing Madrid.

Vueling operates three Airbus A319s and 53 A320s according to Flightglobal's Ascend Online database, to a total of 94 domestic and international destinations.

Vueling route map (Nov 2012) 

 vueling route map
 Source: Innovata Flightmaps Analytics

 

It shares two international destinations, Amsterdam and Copenhagen, with Iberia Express, but both are served from Barcelona.

During the past year, Vueling has remained bullish about international diversification as potential to expand footprint outside Spain and capture new passenger mix. It opened international bases in the French city of Toulouse and Amsterdam, but the established competition in Toulouse has posed problems for expansion scopes and Vueling recently announced its withdrawal.

Iberia Express has been taking over some Iberia routes, but operates uniquely from Madrid.

Domestically, Iberia Express has focused on the southern part of Spain, and especially the Canarias islands since its inception. It serves La Palma, Tenerife, Gran Canarias, Lanzarote and Fuerteventura as well as Alicante, Jerez, Malaga and Seville. Vueling serves most of these destinations from Barcelona.

When launching Iberia Express last March, Sanchez-Lozano reiterated the difference between the two carriers. "There could be some routes overlapping with Vueling but it [Iberia Express] has a different business model. Vueling is not aimed at linking a network and operates point-to point routes from Barcelona," he commented.

Interestingly Vueling, which has always pushed the traditional budget model envelope, has further dipped its head beyond the low-cost segment, having unveiled a new business class offering as part of its recent major expansion from Barcelona. This also includes the addition of some key business destinations including Frankfurt.

Walsh though is comfortable in having a low-cost carrier within the IAG stable. "We made clear when we established IAG that we did see the possibility of having a low-cost carrier brand within it," he says, highlighting its profitability and impressive operating costs. "It ticks all the boxes for us. We think it fits with the strategic objectives we had when we established IAG."

Vueling has based much of its success on its relatively low operating costs, which in turn was something of an inspiration for Iberia Express. These costs could be cut further once it completes an overhaul of its fleet, a tender on which is currently active.

(Additional reporting Olivier Bonnassies)