Should you still invest in British Airways?

May 31, 2017

The start of the May half-term break, combined with a Bank Holiday weekend is exactly when British Airways needed to be running its slickest operation ever, but as you will have seen on the news, the events of recent days couldn’t have been any further from that ideal. A power failure on Saturday morning took out the company’s IT system and the back-up didn’t kick in promptly, bringing a business that was evidently operating close to capacity to a standstill.

 

This is just the latest in a string of Public Relations calamities to hit the airline in recent years, but what’s driving all this - and what does it mean for investors?

 

British Airways is just one part of IAG – International Consolidated Airlines Group – which also owns airlines like Iberia and Aer Lingus. The industry is also notoriously volatile when it comes to trying to make a profit, with the two big variables - oil prices and underlying demand for travel - largely beyond the scope of what an airline can engineer. With this in mind, IAG tasked a fellow by the name of Alex Cruz with streamlining British Airways to improve the return for shareholders. Legroom has been cut to squeeze in extra rows of seats, you now have to pay for food & drink in economy class even if you’re flying for 5 hours down to Cyprus. Even First Class passengers have taken a hit with no more amouse-bouche or flowers in the bathroom!!

 

Despite the media assault in response to the cuts to customer service, it all seemed to be working – at least for the shareholders. More passengers were travelling and in the first three months of the year, which always the slowest for the airline business and even worse this year because of a late Easter, IAG managed to make a profit of EUR170 million. Perhaps most importantly, cash in the bank by the end of March also stood at a whopping EUR7.5 billion, but at what price has this been achieved?

 

One core decision made by BA has been the outsourcing of its IT systems to third parties who would have been competing on many aspects, but price would have been significant given the current focus of the business. Competitor Ryanair was keen to boast this week that it realised the critical role IT plays in the company structure and as such would never outsource it, but just how expensive will this lack of control prove to be? Some estimates put the cost of compensation at £150 million if all the affected passengers know what they are entitled to claim for, but on top of this there’s the good-will. Holidays have been ruined, family reunions cancelled and meetings missed.

 

Analysts had already flagged the risk the airline was running in improving financial performance by chipping away at the product. Once there’s nothing to differentiate you from the masses you can only compete on price, and those with a lower cost base – no pension overheads or staff on contracts that date back in some cases to the days when BA was still owned by the taxpayer – will always be at an advantage when the going gets tough.

 

Shareholders may be basking in the glow of the cost savings of recent years and indeed just six months ago in an investor presentation, IAG lead with the crude headline “Show me the ******* money”, presumably in a boast to the City that they were on a purely profit-driven agenda. Shares also fared reasonably well in the first day of trading after the holiday weekend – even that £150m bill can be paid out many times over from spare cash if needed. But this should be a timely reminder to investors that this is a commodity business.

 

Without that cash buffer – which really should be there to protect against that the next global economic downturn or spike in fuel prices - the share price could have been looking very different this week.