Iberia's credible business model

Sometimes you come across these companies which you almost instantly develop a feeling of admiration for, simply because of their business model. One of those companies for me is Iberia. Iberia Lineas Aereas de Espana S.A. - as it's officially called - has had three difficult years, with competition getting stronger and stronger, especially on domestic and medium haul flights. Competition on medium haul flights (read: flights within Europe to or from Madrid) mainly comes from low cost carriers and Air France/KLM. Especially the low cost carriers are gaining market share rapidly and this has slightly eroded Iberia's market share as well as its margins. A similar thing is happening in the domestic market where SpanAir aims for market leadership in 2009 and high speed train operator AVE will also offer strong competition. In that situation, there are two things you can do: become a price fighter and see margins erode further with at best a stable market share or shift your focus to other markets. Well, Iberia has chosen to do both. The Spanish airline company has decided to increase its focus on long haul and aims to make Madrid the number one hub for flights to and from South America. The past two years, it has been rather successful and saw its position improve into taking over market leadership on Madrid to South America flights from Air France/KLM. Moving up from a current 18.7% towards a 23% market share in 2008 is considered 'feasible', despite tough competition from low-cost AirMadrid as well as Aerolineas Argentinas. In addition to improving its market share on these Atlantic flights, Iberia is also helped by an improving economic situation in South America, which leads to a healthy increase in air traffic. At the same time, Iberia set up its own low cost airline company 'ClickAir' in February this year. Another factor one should take into account is fuel prices. The expectation for fuel prices in 2007 is certainly more favourable than the 2006 situation, which should have a positive effect on corporate earnings. The company's plans to focus on profitability before topline growth - through an increase in business class tickets and self check-in and savings in personnel cost - should create some extra shareholder value. This has led analysts to be very positive about EPS estimates for 2007, which are expected to double. Now one could say that the stock is not undervalued at this time, which is probably true. But against this, the strategy of changing its corporate focus whilst improving profitability is one that certainly seems to pay off. I would therefore still recommend this stock at its current price of Eur 2.81, strongly influenced by its credible business model as well as by recent strong rumours on Lufthansa interests in Iberia. Update: Businessweek reports that AirMadrid has just seen its licence suspended by Spain's Civil Aviation authority, leaving thousands of passengers stranded.