While U.S.-based airlines American Airlines Group, Delta Air Lines, and United Continental Holdings have taken off this year, International Consolidated Airlines Group (NASDAQOTH:ICAGY) (LSE:IAG) has led its shareholders into a turbulent year. So what's behind this airline's drop of 8% so far in 2014?
A multinational airline
Few ordinary flyers would recognize the name International Consolidated Airlines Group, but this company is the combination of two major flag-carrying airlines. In 2011, ICAG was formed by combining British Airways with Iberia, the flag-carrying airline of Spain. However, the two airlines remain separate in their names and their approaches toward branding.
Normally, countries are protective of their national carriers, but competitive pressures have pushed for consolidation in the European airline industry. Air France-KLM (NASDAQOTH:AFRAF) was formed from a 2004 merger of the French and Dutch flag carriers and Deutsche Lufthansa (NASDAQOTH:DLAKY) controls Switzerland's flag carrier, Swiss International Air Lines.
The multinational structure means International Consolidated Airlines Group is exposed primarily to the airline industries of Britain and Spain alongside the European economy.
Troubles in Europe
The past few years have been tough for European airlines for two main reasons: competition and economic conditions. Flag-carrying airlines like British Airways and Iberia have large market positions that stem from their long histories and former government-affiliated status.
But with the deregulation of the airline industry, low-cost competitors have been expanding and taking customers from large flag carriers. Irish carrier Ryanair has been one of the most powerful low-cost competitors and is now posing a threat on many routes currently operated by Europe's flag carriers.
As Ryanair turns up the competition in Europe, the transatlantic market is raising concerns. In July, Air France-KLM issued a profit warning citing overcapacity in this market as a top reason. Competition from discount and Middle Eastern carriers also resulted in Deutsche Lufthansa issuing a profit warning in June that sent its shares and those of other European airlines lower.
The European economy has also been slow, hurting air travel demand. While Air France-KLM and Deutsche Lufthansa mentioned overcapacity as their top reason for the profit warnings, it's clear that economic conditions in Europe are far from ideal and that recovery here could be a major positive for airline bottom lines.
European airlines should expect to see continuing competition as Ryanair and other discount competitors expand. However, this effect could be balanced out if the European economy can return to growth and boost air travel demand.
International Consolidated Airlines Group is also making efforts to cut costs and manage capacity, primarily through Iberia. ICAG now expects that Iberia will post higher earnings despite having flat sales numbers as the airline reduces capacity across the board.
If managed correctly, the current configuration of the transatlantic market could actually carry some upside in the near future. Over the past few years, former major competitors have since formed alliances, allowing greater pricing power. US Airways will now actually be part of American Airlines Group and its alliance with British Airways, while Delta Air Lines has formed a joint venture with Virgin Atlantic. These alliances allow carriers to set prices and fill each other's planes, so taking full advantage of these alliances should be top priority for major European carriers.
Looking at the European airline industry in 2014, it's easy to see that International Consolidated Airlines Group is operating under less than optimal conditions. Profit warnings from Deutsche Lufthansa and Air France-KLM over economic conditions and overcapacity have made European carriers less attractive for investors.
Going forward, International Consolidated Airlines Group is a bet on two main factors: the ability of flag carriers to respond to competition and manage capacity accordingly, and the European economic and air-travel demand pictures.
Alexander MacLennan owns shares of AMERICAN AIRLINES GROUP INC and Delta Air Lines, and has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long January 2015 $17 calls on AMERICAN AIRLINES GROUP INC, long January 2015 $32 calls on AMERICAN AIRLINES GROUP INC, and long January 2015 $40 calls on AMERICAN AIRLINES GROUP INC. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.