FINANCIAL REVIEW

Developments since last report (July 29, 2022)

On August 16, the Group announced that it had exercised its option to exchange the Group's €100 million seven-year unsecured convertible loan to Globalia for a 20 per cent equity stake in Air Europa.

On October 26, IAG's shareholders approved the purchase of 50 Boeing 737 aircraft and 37 Airbus A320neo aircraft. These aircraft, for delivery between 2023 and 2028, will replace existing Airbus A320ceo family aircraft and will contribute to the Group's climate commitments, as well as bringing long-term cost benefits.

Basis of preparation

At September 30, 2022, the Group had total liquidity of €13,488 million, comprising cash and interest-bearing deposits of €9,260 million, €3,259 million of committed and undrawn general facilities and a further €969 million of committed and undrawn aircraft specific facilities. The Group has been successful in raising financing since the outbreak of COVID-19, having financed all aircraft deliveries in 2020 and 2021 and has continued to successfully finance aircraft in the nine months to September 30, 2022; the Group continues to secure aircraft financing on long-term arrangements.

In its assessment of going concern over the period to December 31, 2023 (the 'going concern period'), prepared in the third quarter of 2022, the Group has prepared extensive modelling, including considering a plausible but severe downside scenario and further sensitivities to the downside scenario. Having reviewed these scenarios and sensitivities, the Directors have a reasonable expectation that the Group has sufficient liquidity to continue in operational existence over the going concern period and hence continue to adopt the going concern basis in preparing the condensed consolidated interim financial statements for the nine months to September 30, 2022.

Principal risks and uncertainties

The Group has continued to maintain its framework and processes to identify, assess and manage risks. The principal risks and uncertainties affecting the Group, detailed on pages 100 to 121 of the 2021 Annual Report and Accounts, remain relevant. The Board reviews and challenges management on the risk landscape in the light of changes that influence the Group and the aviation industry.

The Group continually assesses how its principal risks are evolving and how the severity or likelihood of occurrence of risks change with the return to operations as markets have re-opened. It reviews macro-economic and geopolitical events to identify emerging risks and implications for existing principal risks as well as competition and market risk changes, particularly those that could impact operational resilience. Where further action has been required the Board has considered potential mitigations and, where appropriate or feasible, the Group has implemented or confirmed plans that would address those risks or retain them within the Board's determined Group risk appetite.

From the risks identified in the 2021 Annual Report and Accounts, the main risks that continue to be a key area of focus, due to their potential implications for the Group's resilience, are outlined below. Business responses implemented by management and that effectively mitigate or reduce the risk are reflected in the Group's latest business plan and related downside scenarios. No new principal risks were identified through the risk management assessment discussions across the business in the nine months to September 30, 2022.

·      Brand and customer trust. Operational resilience and customer satisfaction build brand value and customer trust. The Group is pro-actively addressing its customer service processes and systems to deliver excellent customer service and support customers through disruption, which will help ensure that our customers choose to fly with the Group's airlines.

·      Critical third parties in the supply chain. Operational staffing shortages at hubs and airports have required capacity adjustments, including managing the impact on British Airways' customers and operations of the decision by Heathrow airport to cap passenger numbers. The Group has pro-actively assessed its schedules to ensure that our customers have sufficient notice of any changes to their flight plans wherever possible and within our control. Learnings from the summer disruptions have been identified and actions to improve resilience have been implemented. The Group continues to work with all critical suppliers to understand any potential disruption within their supply chains from either a shortage of available resource or production delays which could delay the availability of new fleet, engines or critical goods or services.

·      Cyber attack and data security. The threat of ransomware attacks on critical infrastructure and services has increased as a result of the war in Ukraine and the potential for state sponsored cyber attacks. The Group continues to focus its efforts on appropriate monitoring to mitigate the risk.

·      Debt funding. Access to the unsecured debt markets could be restricted for some sub investment grade organisations, which could reduce the external funding options available to the Group. Rising interest rates will also increase the cost for the Group where it chooses to re-finance upcoming maturities due in the next year. The Group continues to successfully secure aircraft financing.

·      Economic, political and regulatory environment. The economic impact of energy shortages and increases in commodity and wage costs has driven significant inflation and uncertainty over the economic outlook. The Group is closely reviewing the impacts of wage and supplier inflation on margins and customer demand. The Group will continue to adjust its future capacity plans accordingly, retaining flexibility to adapt as required and where possible.

·      Event causing significant network disruption. Ongoing labour shortages, threat of strike action and staff sickness from COVID-19 infections have impacted the operational environment of the Group's airlines as well as the operations of the businesses on which the Group relies. Many of these events can occur within a close timeframe and challenge operational resilience. In addition, the Group has significant IT infrastructure changes to complete which could impact operations. The Group is focused on minimising any unplanned outages or disruption to customers with additional resilience built into the airline's' networks.

·      Financial and treasury related risk. Fuel cost increases have been partly mitigated by the Group's fuel hedging policy. Access to fuel hedging instruments or the ability to pass increased fuel costs on to consumers could impact the Group's profitability. The Group continues to assess the strengthening of the US dollar against the euro and pound sterling and the potential impacts on the Group's operating results. All airlines hedge in line with the Group hedging policy.

·      IT systems and IT infrastructure. The Group is reliant upon the resilience of IT systems for key customer and business processes and is exposed to risks that relate to poor performance, obsolescence or failure of these systems. The Group is currently engaged in a number of major programmes to modernise and upgrade its IT systems, digital capability, customer propositions and core IT infrastructure and network, where required. Mitigating actions that prioritise operational stability and resilience have been built into all cutover plans.

·      People, culture and employee relations. The Group recognises the efforts of our staff and their resilience and commitment supporting the ramp up of operations. Resource shortages and the timelines to secure resource, particularly in UK and Ireland, can impact operational readiness and resilience. The Group is focused on measures to attract and secure flight and ground staff into its airlines to enable them to fulfil their schedules and maintain competitiveness. Across the Group, collective bargaining is in place with various unions. The Group is exposed to the risk of the industrial relations action and the operating companies continue to engage in discussions with unions to address and resolve disputes arising within the negotiations.

The Board and its sub committees have been apprised of regulatory, competitor and governmental responses on an ongoing basis.

Impact of commodity prices and foreign exchange movements

Average commodity fuel prices for the nine months to September 30, 2022 were significantly higher than in the previous period, with average spot prices of jet fuel almost double the level of the previous year. Jet fuel spot prices reduced from $1,235 per metric tonne on June 30, 2022 to $965 per metric tonne on September 30, 2022, although prices fluctuated within the quarter and remain volatile.

The average foreign exchange rates for the first nine months of 2022 resulted in the US dollar strengthening 10 per cent against the euro and 7 per cent stronger against the pound sterling, compared with the average of the first nine months of 2021.

The net impact of transaction and translation exchange for the Group for the nine months was €316 million adverse (€90 million adverse in quarter 1, €106 million adverse in quarter 2 and €120 million adverse in quarter 3).

From a transactional perspective, the Group's financial performance is impacted by fluctuations in exchange rates, primarily from the US dollar, euro and pound sterling. The Group generates a surplus in most currencies in which it does business, except for the US dollar, as capital expenditure, debt repayments and fuel purchases typically create a deficit. The Group hedges a portion of its transaction exposures. The net transaction impact on the operating result was adverse by €296 million for the nine months, increasing revenues by €394 million and costs by €690 million.

IAG's results are impacted by exchange rates used for the translation of British Airways' and IAG Loyalty's financial results from sterling to the Group's reporting currency of euro. For the nine months, the net impact of translation was €20 million adverse (€26 million adverse in quarter one, €2 million favourable in quarter two and €4 million favourable in quarter three).

Unless stated otherwise, all variances quoted below compare the first nine months of 2022 with the first nine months of 2021 on a statutory basis (including exceptional items).

Capacity

In the first nine months of 2022, IAG capacity, measured in available seat kilometres (ASKs) reached 75.3 per cent of that operated in the first nine months of 2019. Capacity was steadily increased through the period, with quarter 1 at 65.1 per cent of 2019, quarter 2 at 78.0 per cent of 2019 and quarter 3 at 81.1 per cent of 2019.

The impact of COVID-19 and related travel restrictions was significantly less than in the first nine months of 2021, when many countries were in lockdown or had severe travel restrictions in place. The passenger load factor reached 81.3 per cent in the first nine months of 2022, again increasing across the period, with the passenger load factor in quarter 1 at 72.2 per cent, in quarter 2 at 81.8 per cent and in quarter 3 at 87.0 per cent, which was just 0.7 points lower than in quarter 3 of 2019. There was some impact from the Omicron variant of COVID-19 early in the year, mainly in January and February. Capacity operated out of London Heathrow airport was lower than originally planned at the start of the year and British Airways' capacity was limited to 74.2 per cent of 2019 in quarter 3, up from 57.4 per cent in quarter 1 and 69.1 per cent in quarter 2.

Revenue

Passenger revenue rose €10,880 million to €14,020 million, reflecting the significant increase in capacity operated, together with the positive impact of a 21.3 percentage point increase in the passenger load factor and passenger yields per revenue passenger kilometre (RPK) up 27.0 per cent. The resulting passenger unit revenue (passenger revenue per ASK) was 72.2 per cent higher than the previous year and was up to 91.0 per cent of that seen in the first nine months of 2019. Passenger unit revenue was 11.7 per cent lower than 2019 in the first quarter, 6.4 per cent higher than 2019 in the second quarter and 21.9 per cent higher in the third quarter.

Cargo revenue was up €42 million to €1,216 million, 3.6 per cent higher than in the first nine months of 2021, despite only 480 cargo flights operated in the period, down from 3,334 in the first nine months of 2021, due to the significant increase in the passenger capacity operated. Yields increased 1.8 per cent on 2021, supported by continued global supply chain disruption, particularly in the first half of the year. Cargo carried, measured in cargo tonne kilometres (CTKs), rose by 1.7 per cent. Compared with 2019, Cargo revenue increased by €391 million, or 47.4 per cent.

Other revenue increased by €837 million to €1,444 million, reflecting the recovery in the Group's non-airline businesses, including BA Holidays, Iberia's maintenance and third party handling businesses and IAG Loyalty. Other revenue was 4.0 per cent higher than in the first nine months of 2019.

Costs

Costs were impacted by the significant increase in capacity versus 2021, together with costs in the first half of the year reflecting the need to complete training and maintenance activities ahead of the Group airlines' Summer flying programmes.

Employee costs increased by €1,318 million to €3,417 million, with only minimal use of government wage support and related schemes in the period, as staff were required to resource the significantly increased flying programme, as well as for training and preparation ahead of the Summer flying season.

Fuel costs increased by €3,351 million to €4,400 million. The impact of the increase in commodity fuel price was mainly seen from March and the impact was reduced by the Group's hedging programme. Fuel costs also benefitted from the reduced volume of cargo flights versus the previous year.

Supplier costs increased by €3,686 million to €6,562 million, mainly linked to the significant increase in capacity operated, together with inflationary increases, which were partly offset by the Group's procurement initiatives.

Depreciation, amortisation and impairment costs increased to €1,531 million, partly driven by aircraft deliveries during 2021 and the first nine months of 2022.

Operating costs include a €180 million currency differences charge in 2022 (classified within Supplier costs), versus a €32 million currency differences credit in 2021; currency differences mainly reflect the retranslation of current financial assets and liabilities at the closing foreign exchange rate for the period, which in 2022 reflects the strengthening of the US dollar against both the euro and the pound sterling.

Operating result

The Group's operating profit for the period was €770 million, an improvement of €3,257 million versus 2021. Excluding exceptional items, the operating profit for the period improved €3,404 million versus the previous year, to €739 million.

Exceptional items

In the nine month period, the Group recorded an exceptional credit of €23 million relating to the partial reversal of the fine previously issued by the European Commission, in 2010, to British Airways. There was also an exceptional credit of €8 million, reflecting the partial reversal of aircraft impairments made in 2020, as six Airbus A320 aircraft previously assumed permanently stood down have now been added back to the Group's fleet plans. In the first nine months of 2021, exceptional items included: gains on those fuel and foreign exchange hedges de-recognised in 2020, totalling €158 million; an exceptional credit of €7 million relating to the reversal of lease provisions made in 2020; and an exceptional credit of €13 million relating to the partial reversal of impairments relating to four Airbus A320 aircraft in 2020. See Reconciliation of Alternative performance measures for further information.

Net non-operating costs, taxation and loss after tax

The Group's net non-operating costs for the nine months were €604 million in 2022, compared with €563 million in 2021. The net change in the fair value of financial instruments of €132 million reflects fair value adjustments as at September 30, 2022 of IAG's convertible bond maturing in 2028 and its convertible loan to Globalia, which was made during quarter 2 and converted into a 20 per cent equity stake in Air Europa in quarter 3. Net currency retranslation charges of €305 million reflected the weakening of the euro and pound sterling against the US dollar since the start of the year. Other non-operating credits of €262 million principally reflect gains on derivatives not qualifying for hedge accounting.

The substantial majority of the Group's activities are taxed where the main operations are based: in the UK, Spain and Ireland which have statutory corporation tax rates of 19 per cent, 25 per cent and 12.5 per cent respectively for 2022. The expected effective tax rate for the Group is determined by applying the relevant corporation tax rate to the profits or losses of each jurisdiction. The geographical distribution of profits and losses in the Group, with the average corporation tax rate for entities with losses being lower than the average corporation tax rate for entities with profits, results in the expected effective tax rate being 32 per cent for the nine months to September 30, 2022. The difference between the actual effective tax rate of negative 20 per cent and the expected effective tax rate of 32 per cent is primarily due to the partial utilisation of previously unrecognised tax losses in the Group's Spanish companies, and the impact of the increase in the UK rate from 19 to 25 per cent from April 2023.

The profit after tax for the nine months was €199 million (2021: loss of €2,622 million).

Cash, liquidity and leverage

The Group's cash balance of €9,260 million at September 30, 2022 was up €1,317 million on December 31, 2021. During the nine months 20 Airbus aircraft were delivered (five A350-1000s, five A350-900s, nine A320 Neos and one A321 Neo), together with one Boeing 787-10. Of the aircraft delivered in the period, 13 were financed by the end of September (one A350-1000, three A350-900s, seven A320 Neos, one A321 Neo and one Boeing 787-10).

Total liquidity at September 30, 2022 was €13,488 million, up from €11,986 million at December 31, 2021. Committed and undrawn general facilities were €3,259 million (December 31, 2021: €2,917 million) and committed and undrawn aircraft facilities €969 million (December 31, 2021: €1,126 million). During quarter 3 the Group extended the availability of its $1,755 million revolving credit facility by one year to March 2025.

Net debt at September 30, 2022 was €11,058 million, down €609 million from December 31, 2021. The Group has seen a return to the normal seasonality experience before the COVID-19 pandemic; this seasonality typically results in deferred revenues rising strongly in the first half of the year in advance of peak summer travel, with deferred revenues then falling in the second half of the year and reaching a natural trough in December. This pattern of seasonality would normally result in lower cash and cash equivalents at the end of December and an increase in Net debt.