IAG’s full year results for 2023
Record profit results from IAG for 2023
Two days ago, IAG reported its full year results for 2023. I plan to spend some time digging into the detail of the results and looking at the performance by operating company, but that’s for another post. In this one I’m just going to cover the group headline figures and how they compared to my expectations.
Operating profits hit €3.5 billion, 6.8% above the 2019 level. The news was also good at a pre-tax level, with £3.1 billion of profits, 3.7% higher than 2019. Both figures were all time records for the company. Margins have still not quite recovered to pre-pandemic levels. The operating margin of 11.9% was one point lower than 2019 and the pre-tax margin was down by 1.2 points.
On the chart below, I’ve shown the rolling 12 month figures for both operating and pre-tax profits. You can see that the recovery in operating profit now seems to have hit a plateau, although profits after financing costs continue to improve, as positive cashflows have allowed the company to pay down debt taken on during COVID. Net debt is still €1.7 billion above 2019 levels, but fell by €1.1 billion during the year.
Source: Company reports, GridPoint analysis
Those of you who follow my commentary on the company's results and profit outlook may know that an operating profit of €3.5 billion was what I predicted back in May after the company announced its Q1 results. IAG had started the year with guidance for operating profits of between €1.8 to €2.3 billion, which I thought looked deliberately “low-balled”. By the time of the Q1 results, this had been updated to “over €2.3 billion”. As it became increasingly clear quarter by quarter that the profit guidance was going to be massively exceeded, rather than update the estimate management simply stopped giving explicit guidance for profits. Instead they switched to focusing guidance purely on non-fuel unit costs. At the beginning of the year, that was for a reduction of between 6% and 10%. In their Q3 results announcement at the end of October, they said that they now expected non-fuel unit cost reductions "at the lower end" of this range, i.e. around 6%. Given continued strong revenue performance and company commentary about demand remaining strong, that led me to pencil in a full year profit figure of €3.8 billion after the Q3 results came out.
So although IAG's results for the year were undoubtedly very good, I will admit to having been a little disappointed by the €3.5 billion result.
Where did the shortfall come from?
Why were the results around €300m worse than I was expecting? You’d think that revenue would be the most likely culprit. After all, that should be the hardest part to forecast, especially as the company has avoided providing any explicit revenue guidance. €140m of the shortfall did come on the revenue side, in part because capacity for Q4 came in about 1% lower than expected. IAG said that this was due to higher levels of disruption, especially weather-related. Unit revenues were also about 1% lower than I had assumed. I’d based my forecast on trends in unit revenue compared to 2019. The following chart shows the quarterly trend and how the outturn for Q4 looks compared to my assumption.
Source: Company reports, GridPoint analysis
Somewhat offsetting the revenue shortfall, fuel costs came in 1.6% better than my forecast, in part due to the lower capacity operated. The revenue and the fuel cost variances together accounted for about a third of the shortfall.
That leaves two-thirds of the "missing profit" coming from non-fuel unit costs. Remember, this was the one area where there was explicit guidance of “around 6%” and I assumed that the number would be hit. That guidance was reiterated as late as the end of October, with only two months of the year still to run. With the release of the Q4 figures, we now know the out-turn was 4.4%. That sounds like a small difference, but it is worth over €200m. With 9 months of the year already "in the bag", Q4 non-fuel costs appear to have come in around 6% higher than expected at the end of October. I find that very hard to understand.
On the investor call, IAG's CFO explained the shortfall as having been due to "cost-of-sale impact from strong performance in Iberia third-party MRO". In 2022, Iberia's MRO revenues for the entire year were only €581m, or about €145m a quarter. A lot of that was from other IAG companies, so the third party revenues were even lower. How could a business of that scale generate a quarterly variance in cost of sale of anything like €200m?
The other factor mentioned by IAG's CFO was higher disruption than expected, especially weather-related. He called out the reduction in ASKs that had come from that. It is true that a lower ASK figure than planned will generate higher unit cost figures, due to fixed costs. We already saw that ASKs in Q4 were about 1% lower than expected, but the impact of lower ASKs on the full year unit cost figures would only be a quarter of that, even if 100% of costs were fixed. So the "mechanistic" effect seems like it could explain very little of the variance. There will have been incremental costs from disruption, such as customer compensation, but a lot of that ends up in revenue reductions not higher costs.
In any event, I'm left confused as to how there was such a big deviation from the guidance on costs. At the margin, CFO’s have quite a bit of discretion when closing the year end and a cynic might suspect that some money might have been “put behind the clock” for next year. Maybe IAG already knew at the end of October that unit cost reductions would be only 4.4%, but decided that was close enough to 6% to be covered by the “around” qualifier? Or perhaps IAG is just really bad at forecasting costs.
Guidance for 2024
During 2023, I expressed my frustration on several occasions at the lack of clear profit guidance from IAG. I understand that there are many uncertainties in the airline business, but during all my time at BA and at IAG, that never prevented us giving a pretty clear steer to the market on the number the management team was committed to delivering. The figure was designed to be stretching but achievable, and I always felt that having a public profit target was very helpful in focusing efforts across the organisation.
Although lots of companies stopped giving earnings guidance during COVID due to the extreme uncertainty, surely that is behind us now? IAG seems to have been going in the opposite direction. Having started 2023 with what seemed to me to be an obviously "low balled" range for profits, the company pretty quickly stopped giving profit guidance at all. For 2024, even the guidance for non-fuel unit costs has become more vague - "up slightly" is all we are told.
For 2024, IAG has tried to put the focus of its guidance on free cash flow. Specifically, it is saying: "Generating significant positive free cash flow after investing €3.7 billion of capex". By way of reference, on IAG's definition of free cash flow, €1.3 billion was generated in 2023, after investing €3.5 billion.
What does IAG's guidance on free cash flow suggest about profits? It is basically impossible to tell. To get from profit to free cash flow involves adjusting for several quite volatile items, like working capital and FX movements. I don't even know what the guidance really means for free cash flow. What does "significant" even mean in this context? Would €500m of free cash flow qualify as significant? If so, that would leave room for a big drop in both cash flow and profits whilst still hitting the guidance.
IAG's CFO did drop one hint about 2024 profits during the presentation. He mentioned that the consensus operating profit figure from analysts is currently around €3.4 - 3.5 billion, which is basically at or slightly below 2023. He has previously reminded analysts that if the company's internal view was very different from the consensus, they would be forced to issue a statement. What he seemed to be saying is that although IAG thinks 2024 profits will be similar to 2023 (which sounds about right to me), it isn't prepared to explicitly say so, even verbally on the analyst call, let alone put it in writing or risk being held to it.
Why does any of this matter?
Despite record profit performance in 2023, IAG's shares remain in the doldrums, as you can see from the following chart. Basically the shares have traded sideways for four years now, after collapsing when COVID basically shut down the industry at the start of 2020.
Source: Yahoo. Price adjusted for rights issue.
At the end of 2019, IAG's market capitalisation was €14.6 billion. The share price at that time was actually depressed by worries over EU ownership and control issues brought on by Brexit. But even though those issues are now resolved and profit after tax was 11% higher in 2023 than 2019, the market cap today is only €8.6 billion, 40% lower than it was back then.
That means that the trailing P/E ratio has declined significantly. It wasn’t good in 2019 and now stands at a shockingly low 3.4x. I take that as evidence that investors have no confidence in the sustainability or reliability of IAG's earnings. I can’t help but think that IAG's slipperyness on profit guidance is part of the reason why. If the people in control of the business and with access to the best possible information aren't willing to put their reputations on the line by setting out a clear target, why should they expect investors to have any confidence?
Maybe the switch to a focus on cash flow reflects a belief that what investors want from airlines, especially those without a strong growth story, is hard cash, not paper profits. But from that perspective "free cash flow" is just a stepping stone to what investors are really interested in - cash distributions, in the form of dividends and buy-backs. For the moment at least, IAG is being vague about its intentions on that front too. More hints were dropped on the investor call, but nothing concrete about timing or quantum.
As with all cyclical stocks, IAG's share price could take off if the market enters a pro-cyclical phase. Absent that, it seems likely to me that the shares will continue to move sideways until investors see something more concrete on profit guidance or cash distributions, and ideally both. The two obvious occasions for IAG to provide that would have been IAG’s investor day in November or this week’s full year results announcement. Both Ryanair and easyJet announced that they would be paying dividends in 2024 back in November, so IAG is already late to the party.
My best guess is that IAG is waiting to close the last of their outstanding pilot negotiations before announcing cash distributions or providing clearer profit guidance. In any event, despite the record profits reported this week, it looks like IAG’s long-suffering shareholders will have to wait a little longer.
