Air France-KLM Stock Downgraded by Morgan Stanley

Shares of Air France-KLM (EPA:AIRF) fell over 1% on Tuesday. This decline followed Morgan Stanley's downgrade from an "equal weight" to an "underweight" rating, citing various structural and financial challenges.

Reasons for Downgrade

The downgrade is based on Morgan Stanley’s updated assessment of Air France-KLM’s valuation and profitability compared to its industry peers. The reassessment examines key financial indicators such as capital intensity and maintenance costs, where Air France-KLM appears less advantageous than competitors like Lufthansa and IAG.

Market Exposure Concerns

The airline’s exposure to the Asia-Pacific and Middle Eastern markets is particularly concerning due to slower demand recovery and intense competition from Asian airlines, which has pressured pricing and load factors.

Revenue Challenges

Reliance on corporate travel and specific international markets has created a difficult revenue environment, while other regional markets are recovering more quickly.

Financial Metrics and Accounting Practices

Morgan Stanley highlighted that Air France-KLM's accounting practices, especially regarding aircraft maintenance provisions, influence reported costs. The airline provisions a larger portion of maintenance costs upfront than other European carriers like IAG, inflating expenses.

Valuation Methodology Shift

The analysts changed their valuation approach from EBITDA to EBIT to better reflect operational performance by accurately capturing maintenance costs. This has exposed Air France-KLM’s high capital intensity, especially concerning fleet maintenance and debt, leading to a less favorable EV/EBIT valuation.

Free Cash Flow Outlook

The forecast for Air France-KLM's free cash flow also looks weak, anticipating negative cash flow in 2025 and 2026. This situation partly results from the repayment of social charges deferred during the COVID-19 pandemic, combined with a larger debt burden than sector peers.

Future Concerns

Morgan Stanley warns that ongoing financial stresses will keep the airline’s leverage above that of Lufthansa and IAG, raising concerns about its ability to handle potential downturns or rising costs.

Despite accounting adjustments, Air France-KLM's valuation remains above IAG's, suggesting the stock is currently overpriced when considering its financial standing and growth prospects.

Price Target Adjustment

Consequentially, Morgan Stanley adjusted its price target for Air France-KLM to €7.10, a reduction from previous estimates. The brokerage underscores that the airline’s challenging cash flow dynamics, weaker demand from critical markets, and high relative valuation pose significant risks to the stock.