Air France-KLM : Update of our recommendations following the release of the 'Trust Together' plan and Q3 2016 earnings

Tuesday 22 November 2016 - Equity data - Reco: Neutral - Target: € 6.20 - Equity analyst: Yan Derocles - [email protected] - +33-1 44 51 88 57 - ESG analyst: - Corporate Governance: High risk (4) - / - Next events: - 08/12/2016: traffic in November - 09/01/2017: traffic in December - 08/02/2017: traffic in January - 16/02/2017: 2016 FY earnings - 08/03/2017: traffic in February - 10/04/2017: traffic in March - 04/05/2017: Q1 2017 results - - - - - - We are maintaining our Stable Credit Opinion and our Shadow Rating at 'BB’, following the Q3 2016 earnings release and the first elements concerning the 'Trust Together' plan. The group’s deleveraging process is still under way, as is the objective of achieving positive FCF year after year. We keep, however, a negative bias to recurrent social conflicts within the group, which are prompting concerns, in the long run, about its ability to adapt and, in the short term, raising the risk of a costly strike. This explains the fact that the Air France-KLM bonds are trading at wider levels than those of other “BB”-rated issuers. - Compared to our latest study published on 14 September 2016 ("Air Transport: Notice of turbulence in the European skies”), - . We are maintaining a Neutral recommendation on AFFP 18 notes, which can be kept in the portfolio. Compared with the BB/BB- peer bonds in our sample, the premium offered is about 50bp, which we consider to be consistent with the historical average. - . We are lifting our recommendation on the AFFP 21 note from Reduce to Neutral, given that its spread widening since mid-September (+20bp, vs. -35bp tightening on average for our sample of rated peers), following the issuance of the new AFFP 22 bond which we also initiate at Neutral. For the 2021 and 2022 notes, we estimate that, compared with the BB/BB- peers, the premium offered is at 70-80bp which we consider to be “fair” vs. the premium offered on the 2018 paper, given that they are structurally subordinated to the latter (i.e. the 2021 and 2022 bonds do not benefit from direct guarantees from subsidiaries, as opposed to the 2018 and the OCEANE 23 notes). - . We are maintaining a Neutral recommendation on the 2013 OCEANE (put in 2019). - . We are refining our position to Buy & Hold on the AFFP Perp. bond call 2020, given the yield offered at the call (6.1% over four years), while the step-up appears as a strong incentive to repay securities on that date. Among the hybrids of our universe, only the 4.87% perpetual COFP bond offers a better yield at its first call in 2019 date, which can be explained by the fact that there is a higher risk that the call will not be exercised at that date, but rather at the second call date in 2024 when the group loses the benefit of its Equity Content (in this case, the yield would be at 5.8% at the call in 2024). - ( What would make us change our recommendation on senior unsecured bonds: - - from Neutral to Buy? The confirmation of a renewed social dialogue, which would facilitate a reform of the group, enabling it to improve its margins and claw-back its market shares in Europe. We would see this as a signal to “re-rate” the credit risk perception of the name. - - from Neutral to Reduce? The inability of the new management to re-establish dialogue with the unions, making it much more difficult to continue the group’s restructuring, the intensification of competitive pressures given the deterioration of the tourism sector in Europe. - - >