January 4, 2019 / 3:25 PM / 6 months ago

Breakingviews - Hapless oil bets will drive airline M&A

A Lufthansa Airbus A321-100 airplane takes off from the airport in Palma de Mallorca, Spain, July 29, 2018. Picture taken July 29, 2018.

LONDON (Reuters Breakingviews) - Ropey bets on the price of oil will drive European airline M&A in 2019. The price of a barrel of crude is unusually volatile heading into the New Year. The majority of airlines are heavily hedged against sky-high values, but it’s equally possible Brent will bottom out far below its 2018 peaks. How things pan out will dictate how many weaker outfits get taken out. The cost of refuelling is crippling Europe’s airlines. Over the past three years, the cost of a barrel of jet fuel has doubled to nearly $75, according to data from the International Air Transport Association (IATA). For the year ahead airlines are bracing for further strain, with easyJet, Ryanair, IAG, Deutsche Lufthansa and Air France KLM having already warned that their fuel bills will crank up by hundreds of millions of euros. Although rising fuel prices are hardly a new phenomenon, they follow increased competition from increasingly larger planes. This makes it harder for carriers to raise airfares to shoulder some of the pain. For 2019, a number of big carriers have decided to pay up to take the risks off the table. Michael O’Leary’s budget airline Ryanair has hedged 90 percent of its fuel bill. Similarly, German carrier Lufthansa has hedged 77 percent of its fuel costs. Contrast that with highly levered players like Norwegian Air, which has no such buffer – it has only hedged 15 percent. Smaller airline Wizz Air also looks exposed having only hedged 41 percent. With Brent having fallen precipitously in the last few months of 2018 to below $60 a barrel, these companies willing to take a chance currently look smart. Those who have bought pricey hedges, meanwhile, risk having spent precious shareholder funds for nothing. Still, if President Donald Trump decides to enforce Iranian sanctions in earnest, oil prices could snap up again as a chunk of supply is removed from the market. If so, Ryanair will look well placed to pounce as unhedged peers get into trouble. Its shoestring budget and jam-packed planes will deliver an operating margin of 25 percent in 2019, according to Refinitiv data, and its debt is relatively low. As costs rise, it can take on new routes and even buy up smaller airlines as they collapse. Lufthansa, although on a lower margin, is hoping to charge more for first class passengers to manage extra costs, and says it is also on the prowl for acquisitions. If oil prices do snap back up, opportunities will appear.

- This is a Breakingviews prediction for 2019. To see more of our predictions, click reut.rs/2R6H5pG

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