View from City Road: BA suffers in unfriendly skies

THE IMPACT of sterling's demise on British Airways' third quarter - some pounds 25m off operating profits and pounds 15m on the net interest bill - was severe and will start to move in the right direction fairly shortly. But it should not obscure the fact that, allowing for unquantified losses at Dan-Air, underlying trading conditions are not getting any better and in some respects they got worse in the last three months of 1992.

The poor environment for airlines - a diminished band of premium-paying travellers, pricing pressures, low passenger yields and rising capacity - will also draw even greater attention to BA's financial position. A pounds 510m bill for Qantas and USAir and projected gearing of 160 per cent must again raise the question of future fund-raising.

BA is reasonably closely matched in that 60 per cent of turnover and 50 per cent of operating expenditure is in foreign currencies. Unfortunately, advance payments for flights mean there has been a lag before revenues rise to match costs when both are translated into sterling.

Revenues in sterling terms have now started to catch up with the rise in costs. But some parts of the rise in operating expenditure, such as landing fees, have had nothing to do with exchange rates and will not be matched.

Negative influences are bearing down on underlying revenues. Passenger volumes are still moving smartly ahead, but growth in revenue passenger kilometres slowed from 12.7 per cent in the second quarter to 9.7 per cent in the third.

But highly competitive pricing among airlines, which will only be stimulated by European deregulation, and lack of business passengers continued to push down yields, or the amount of revenue extracted for each passenger kilometre, by 5.1 per cent.

At the same time, the growth in BA capacity coming on stream rose by 11.2 per cent in the third quarter, forcing down the passenger load factor from 68.4 per cent to 67.5 per cent and putting further pressure on BA's operating economics.

Fortunately BA is continuing to deliver on productivity as a 13 per cent improvement led to a 1.9 per cent drop in employee costs. After a likely pounds 30m loss in the fourth quarter, BA's pre-tax profits could rise from pounds 210m to over pounds 300m, implying a multiple of 8.5 at 276p and a yield of 5.2 per cent.

BA shares have underperformed since the late summer. Until the airline world turns friendlier, a re-rating seems improbable.

(Photograph omitted)