Investing.com -- Shares of Air France-KLM (EPA:AIRF) were down over 1% on Tuesday after Morgan Stanley (NYSE:MS) analysts downgraded the stock to an "underweight" from “equal weight” rating, citing several structural and financial challenges.
The downgrade reflects Morgan Stanley’s revised view of Air France-KLM’s valuation and profitability prospects relative to its industry peers.
This shift in perspective follows a reassessment of key financial metrics, including capital intensity and maintenance costs, where Air France-KLM appears less favorable than competitors like Lufthansa and IAG.
Morgan Stanley pointed out that Air France-KLM’s exposure to the Asia-Pacific and Middle Eastern markets has been a persistent concern due to slower demand recovery and stiff competition from Asian carriers, which has exerted pressure on the airline’s pricing and load factors.
Additionally, the airline’s reliance on corporate travel and these international markets has created a challenging revenue landscape, with other regional markets recovering at a quicker pace.
The analysts flag how accounting practices, particularly for aircraft maintenance provisions, impact Air France-KLM’s reported costs.
Compared to other European carriers, Air France-KLM provisions for a larger portion of maintenance upfront. This approach inflates expenses relative to peers like IAG, which allocate costs differently.
Morgan Stanley’s analysts adjusted the valuation methodology from EBITDA to EBIT, favoring this approach as it offers a clearer view of the company’s underlying operational performance by capturing the full maintenance costs more effectively.
This shift has further exposed Air France-KLM’s capital intensity, particularly its fleet maintenance and high debt, resulting in a less favorable valuation on an EV/EBIT basis compared to other airlines.
Air France-KLM’s free cash flow outlook for the upcoming years also appears weak, with projected negative cash flow in both 2025 and 2026.
This cash drain is partially attributed to ongoing repayments of social charges deferred during the COVID-19 pandemic, along with a heavier debt burden compared to sector peers.
Morgan Stanley estimates that these financial strains will keep the airline’s leverage higher than both Lufthansa and IAG, raising concerns over Air France-KLM’s ability to navigate potential downturns or rising costs effectively.
Even after accounting adjustments, Morgan Stanley found that Air France-KLM's valuation remains higher than that of IAG, leading to the conclusion that the stock is currently overpriced relative to its financial standing and growth prospects.
With these considerations, Morgan Stanley adjusted its price target for Air France-KLM to €7.10, down from prior levels, reflecting a cautious outlook on the airline’s ability to achieve industry-average margins and growth rates.
The brokerage emphasizes that the challenging free cash flow dynamics, weaker demand from key markets, and high relative valuation collectively pose significant downside risks to the stock.