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Air France Swaps Beat Peers on Debt-Cut Plans: Corporate Finance

Air France Swaps Beat Peers on Debt-Cut Plans
Air France-KLM is cutting jobs, merging units and boosting no-frills flights to try and head off a fourth straight annual loss caused by higher costs and competition from budget airlines. Photographer: Antoine Antoniol/Bloomberg

Air France-KLM Group’s effort to cut the biggest debt pile of any European airline prompted a two-month rally in its credit that’s leaving peers behind.

The cost of insuring the debt of Europe’s biggest airline fell 30 percent to a five-month low since Air France-KLM unveiled a reorganization plan on May 24 that includes 2 billion euros ($2.5 billion) of debt reductions. The decline is the steepest among credit-default swaps of European carriers including Deutsche Lufthansa AG, British Airways and SAS Group, the Nordic region’s biggest airline.

Air France-KLM is cutting jobs, merging units and boosting no-frills flights to try and head off a fourth straight annual loss caused by higher costs and competition from budget airlines. The savings plan reduced its second-quarter operating loss by more than 50 percent to 66 million euros, beating estimates as sales increased.

“The advances in the cost cutting plans, especially the reduction of the highly protected French workforce, is an important milestone in its return to profitability,” said Manuel Herold, a credit analyst at UniCredit SpA in Munich. “Air France-KLM bonds and credit-default swaps are likely to outperform the market on a short-term perspective.”

The extra yield investors demand to buy Paris-based Air France-KLM’s 700 million euros of 6.75 percent securities due 2016 instead of benchmark German government debt has shrunk to 594 basis points, or 5.94 percentage points, from a record 766 basis points on July 17, according to data compiled by Bloomberg. The 23 percent decline compares with a 7 percent drop to 254 basis points in the spread of Lufthansa’s 6.5 percent bonds due 2016.

Crisis Headwinds

Air France-KLM, created in 2004 from the merger of the French and Dutch carriers, faces headwinds from Europe’s deepening debt crisis. The International Air Transport Association in June doubled its loss forecast for the continent’s airlines to $1.1 billion this year and said its $3 billion profit prediction for carriers around the world may be reduced if Europe’s economy worsens.

Air France-KLM said it would eliminate more than 5,000 jobs under the turnaround plan, known as Transform 2015 and which Chief Executive Officer Jean-Cyril Spinetta said is needed to guarantee the airline’s survival. Under the plan, the airline plans to lower net debt to 4.5 billion euros from 6.5 billion euros at the end of 2011.

Brigitte Barrand, a spokeswoman for Air France-KLM in Paris, declined to comment.

Swap Drop

Credit-default swaps on Air France-KLM dropped to 877 basis points today, from 1,226 on May 24, Bloomberg data show. Swaps protecting British Airways, a unit of International Consolidated Airlines Group SA, fell 18 percent to 639 basis points in the same period, while Lufthansa dropped 13 percent to 281 basis points. Contracts on SAS were little changed at 1,332 basis points.

The price of Air France-KLM’s swaps is still higher than the 543 basis-point average for 2011, Bloomberg prices show. The contracts rose to a record 1,332 basis points on May 21, three weeks after the carrier reported a bigger-than-expected operating loss for the first quarter.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point equals 1,000 euros annually to protect 10 million euros of debt.

“Air France’s CDS will continue to tighten in the next months due to efficient management and a solid debt restructuring plan,” said Pierre Bergeron, a credit analyst at Societe Generale SA in Paris. “The spread between Air France and its rivals will narrow further,” he said, without providing specific numbers.

Net Debt

Air France-KLM reported 6.2 billion euros of net debt at the end of June, which compares with Lufthansa’s 2.1 billion euros at the end of the first quarter and 1.1 billion euros at International Consolidated Airlines Group, or IAG, Bloomberg data show.

The Paris-based carrier has 2.9 billion euros of borrowing coming due in 2013 and 2014, according to its website. The company’s unsecured debentures include 1.45 billion euros of senior bonds and 1.1 billion euros of convertible notes.

Air France-KLM’s debt-to-equity ratio rose to 1.28 times at the end of June compared with 1.07 times in 2011 because of the cost of its reorganization, the company said in its second-quarter results on July 30.

The airline isn’t rated by Moody’s Investors Service, Standard & Poor’s or Fitch Ratings.

Yield Plunges

Air France-KLM has risen 6 percent this year to 4.21 euros a share as of 5:05 p.m. in Paris, boosted by an 8 percent surge this week after its second-quarter results.

The deepening European slump means it’s tougher to increase prices this year, forcing some airlines to idle aircraft and raise fares. Air France-KLM’s quarterly fuel bill advanced 13 percent to about 1.9 billion euros and will reach 9.4 billion euros for the year, an increase of about 400 million euros.

Air France-KLM’s Transform 2015 plan will combine its European operations into three units, including a single division covering smaller cities. The carrier’s job restructuring was backed by ground workers and pilots last week, though cabin crew groups still oppose the plan.

“The agreements with some of the employees on the restructuring and the second-quarter results are early signals that the restructuring is going to happen” said Arnaud Colombel, a fund manager of CPR Asset Management in Paris, which is considering buying debt of European airlines after selling their holdings in March.

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