IAG’s new Spanish CEO has tough choices to make back home

Luis Gallego faces tough challenges right out of the gate. The new chief executive officer of British Airways parent IAG SA must decide on job cuts, an uncertain takeover deal and the future of once-lucrative long-haul routes, in an aviation world laid waste by the coronavirus crisis.

The Spaniard succeeds Willie Walsh, who created IAG through the purchase of Iberia by British Airways in 2011. Just recently, Walsh announced 12,000 job losses at BA in response to the pandemic. But the Irishman has left some key decisions open, giving Gallego a chance to show he’s learned from the consummate cost cutter.

“He has been my natural successor for several years,” Walsh said of Gallego prior to standing down at IAG’s annual investor meeting Tuesday. At the same time he warned of the challenges ahead, saying each group airline must shrink its size and cost base to compete in a “decimated” market.

Walsh said other issues including the role of IAG’s Level arm, which is being refocused on its original business of providing cheaper long-haul flights out of Barcelona. IAG Chairman Antonio Vázquez said the acquisition of Air Europa, which the company is looking to renegotiate following the collapse in global demand, could come later this year or early 2021.

Shareholders at the meeting approved a key 2.75 billion-euro ($3.3 billion) rights offering backed by No. 1 investor Qatar Airways. The measure drew 99% support, IAG said in a statement. A separate advisory item on directors’ pay, which had generated controversy over Walsh’s bonus, attracted 72% support.

Gallego, 51, held various posts at Spanish airlines before joining IAG. He later led Iberia’s regional arm before becoming CEO in 2013. IAG’s leadership change extends the increasingly Spanish dominance of IAG at executive level, with BA, Iberia and Level run by countrymen of Gallego. Vázquez will be replaced by Javier Ferrán, another Spaniard, when he retires in January.

That’s unlikely to make tough decisions in Spain any easier, with the country set to suffer one of the deepest recessions in the euro area this year and recover only gradually from the virus shock, according to forecasts from Bloomberg Economics.

Walsh, who turns 59 next month, is handing over the reins after delaying his exit as CEO by almost six months to navigate IAG through the industry’s worst-ever crisis. The pandemic reversed decades of growth, shutting down flights for months and resulting in a demand slump that could see traffic remain in the doldrums for years.

Still, London-based IAG is regarded as one of the best-placed European carriers. Walsh successfully defeated unions to push through revised labor contracts and cut in-cabin costs with measures such as simpler food.

The airline has confronted the crisis without falling back on the billions in direct state aid that have propped up Air France-KLM and Deutsche Lufthansa AG.

“Luis Gallego carried out a tough restructuring of Iberia after the global financial crisis when his predecessor had struggled to deliver it,” said Andrew Lobbenberg, an airline analyst at HSBC in London. “The question is how well his expertise will translate to a multinational environment.”

Gallego’s Worry List

Six issues that IAG’s new boss needs to confront:

Spanish Jobs

Walsh announced swingeing cuts at BA even as the U.K. business tapped state furlough funding designed to obviate the need for drastic reductions. He was less vocal on required measures in Spain, where 14,000 Iberia employees and 4,000 at Vueling are currently laid off on government support, according to research from consultants Five Aero. Spain may ease the pressure by extending the program through the end of 2020, while there are also limits on how quickly people can be fired following the end of furlough aid.

Air Europa

IAG has said that the 1 billion-euro purchase announced in November must be revised to reflect the realities of post-virus travel. Gallego has said he’s still keen on a deal that would consolidate the group’s hold on the Spanish market, expand its network and add prized Boeing Co. 787 Dreamliner jets, and Vázquez reinforced that enthusiasm. But the long-haul leisure sector on which Air Europa is focused is still struggling to emerge from the coronavirus lockdown, making a takeover less attractive. Walking away would plunge the smaller carrier into crisis and put several thousand jobs at risk, making it a tough choice for a Spanish CEO. Gallego will be seeking a price cut of about 50% to go ahead, according to local press reports.

Boeing Max Deal

Gallego must decide whether to go ahead with the purchase of 200 Boeing 737 Max jets after IAG unveiled the non-binding agreement at last year’s Paris Air Show, providing a surprise boost for a model that had been grounded worldwide after two fatal crashes. Walsh said then that he had faith in the Max’s safe return and that the planes would establish a mixed short-haul fleet alongside existing Airbus SE jets. Since then, fixes to the Max have suffered repeated delays and the aircraft is only now nearing a return to the skies. The drop in demand in the wake of the pandemic might mean that the mammoth order is no longer needed.

M&A Prospects

Beyond Air Europa, IAG may be presented with further purchase opportunities as ailing carriers are tested by the winter low season, during which almost all European operators make a loss at the best of times. The company last year made unsuccessful bids for Norwegian Air Shuttle ASA, which had emerged as a competitor with low-cost flights to North America from London. With the Scandinavian company slashing its fleet and hunkering down after a debt crisis, a new approach could be an option. Still, HSBC’s Lobbenberg says that given the level of uncertainty surrounding the virus, IAG will most likely take its time and see how its peers fare before indulging in a shopping spree.

Trans-Atlantic Trouble

The biggest immediate concern for Gallego may be the continued collapse of demand on trans-Atlantic routes that represent the world’s biggest market for premium travel and are IAG’s prime profit generator. City pairs such as London to New York remain all but shut down by travel restrictions. The group offered almost 7 million seats across the Atlantic last year, making it the No. 1 operator—and now the most exposed. IAG will need to minimize losses in the market while ensuring it’s ready to seize on any pickup, which might come with creation of so-called travel corridors linking lower-risk locations.

Growth Bets

With travel in the doldrums the CEO needs to pick his targets for expansion carefully. Spain became a major focus under Walsh, but can only soak up so much capacity. British Airways, still easily the group’s biggest profit generator, remains hemmed in by the lack of new operating slots at London’s Heathrow airport, whose owners have said that the virus’s long-term impact is likely to delay a new runway by as many as five years into the 2030s. BA must also confront the challenge of a potential no-deal Brexit in just a few months. In short-haul markets, low-cost arm Vueling has struggled to match specialist discounters led by Ryanair Holdings Plc, and also overlaps with Level, initially founded as a no-frills long-haul carrier.