Air Baltic - Recap Scenarios - Initiation
All,
Air Baltic | Client Call | Tuesday 14 April 3 pm UK, 10 am EST.
Please find our initiation on Air Baltic here.
Not fully in control of their costs, highly operationally leveraged, exposed to commodity swings and economic cycles, airlines can spend a lot of time making no money at all, or losing money, and then it tends to be a lot. Air Baltic has been losing money, and while Iran gets the blame for the emergency loan plans that are being sent to parliament, those who have been following it have seen the situation coming a long time ago. The latest fuel prices are merely the nail in the coffin. So when is it a good idea to get involved?
Investment Consideration:
- We are not yet buying a position in the bonds. In the short term Latvia's hands are bound by a national election in October and complex EU regulation. Meanwhile, the Saeima (Latvian Parliament) will want to see a process. We struggle to see a coordinated approach in time for the H2 WC outflows unless Lufthansa buys out / transfers the ACMI operations into another vehicle for a cash consideration, leaving Latvia with a smaller bill and in control of a network carrier that would still have to restructure its bonds, but has more time to do it. That is not impossible at all, but it narrows the path considerably.
- The May coupon is very unlikely to be paid, as evidenced by the company’s reported consultations with legal advisors. with legal advisors. We will likely assess pricing and optionality when that is a fact.
- On the upside, even if not this year, bonds could see a large Latvian cash injection into the business and return to near par. That the bonds can be regularly refinanced on the business metrics we are forecasting by 2028/29 would remain uncertain. However, on the downside, their collateral struggles to be worth 15-20c/€, and for a near binary situation, that's a long way down from current levels. Being fundamental investors, until we have a certain scenario, we are unlikely to buy these bonds above 40c/€ as the position would not be scalable with as much risk.
Key Conclusions:
- Air Baltic is effectively out of cash, reliant on stretched payables with no unencumbered assets. Seasonal WC inflows are unlikely to bridge the Q1 trough. Advisors have been engaged, and the Latvian state is conditioning further support on a credible business plan(Recent Trading).
- Near-term liquidity is strained: ~€41m carbon allowances due Sep-26 (40% hedged) and minimal fuel hedging (~10% at €567/t on 165kt burn for the remainder of the year). Sensitivity is ~$16.5m per $100/t, we estimate a hit of ~€50m. Out of a general cash requirement of €250m, it's a significant problem, but pales in the face of general cost inflation (Recent Trading).
- Cost inflation appears structural (CASK +6%, navigation +28%, crew +10–24%). While revenue tailwinds exist—resolution of the Pratt & Whitney engine disruption (zero AOG), five Airbus A220 deliveries in H1’26 (~10% capacity), strong ACMI-out margins (notably with Lufthansa), and recovering Baltic yields (RASK >2023)—these do not fill the immediate funding gap. Guided 2026 15–20% capacity growth is credible, but liquidity will have needed support already and will continue to do so (Recent Trading).
- Downside bond recoveries are de minimis: weak security implies ~15c/€; a UK plan or US Chapter 11 would likely equitise most of the stack given the capital needed to preserve going concern before it is vastly diluted with the fresh cash Air Baltic requires. On the upside, Latvia may choose to save face and inject the cash, discarding the ~€325m deleveraging opportunity (Recap Scenario). State support may reflect IPO ambitions and national champion considerations. A strategic bid from Lufthansa is plausible to avoid an auction, though the Saeima is likely to require a process. A mid-case implies bond recoveries of ~50c/€ with reduced coupons and worthless equity - if any (Recap Scenario).
- Valuation is highly path-dependent: even with four years of fleet growth, moderated cost inflation and ~€250m equity injection, EV is insufficient to cover bonds. A ~10% cost reset could bridge the gap, but ~75% of costs are exogenous, limiting executability (Valuation).
- Structurally, this is a marginal business: hybrid model (between LCCs such as Ryanair / Wizz Air and network carriers like Air France-KLM / Lufthansa) with higher CASK than ULCCs and insufficient pricing power to absorb the cost spike. To achieve 1.5x interest cover by ’27 would require 35–40% fare increases—implausible in a VFR-led CEE market. Growth (additional A220 deliveries, 2/3 ACMI) is necessary but increases lease leverage; absent fuel shocks, the rumoured €150m state support is tight, rising to ~€200–300m with current fuel assumptions (Model; Industry; Company).
Recent Trading:
- Air Baltic is out of cash, has no unencumbered assets, and is leaning on payables - the H1 WC inflow cycle likely won't bridge the Q1 trough on its own. Legal advisors are being hired and Latvia has demanded a business plan before providing further support.
- The near-term cash picture is worsened by two deferred outflows: ~€41m in carbon allowances due September 2026 (only 40% hedged), and enormous fuel exposure with only 10% hedged at €567/tonne on 165,000kt burn. Every $100/tonne move costs $16.5m; our estimated hit has grown to €50m.
- The cost base has stepped up permanently — CASK +6%, navigation +28%, crew +10-24%. Management call these one-off catch-ups but they look structural to us. Revenue needs to catch up, and there are reasons to think it can: the P&W engine crisis has resolved (zero AOG), five A220 deliveries in H126 add ~10% capacity, ACMI-out summer is fully sold at margins above scheduled ops, and Baltic yields are recovering with RASK back above 2023 levels. We find the guided 15-20% capacity growth credible and safe for some allowance for distraction this year have modelled accordingly.
- But none of that fixes the near-term hole. The Lufthansa convertible and state co-investment (€28m combined) are immaterial against the funding gap. A recapitalisation needs to be in place before September — that's when the carbon allowances fall due and the summer WC tide goes out. The question for us is what form it takes and where bondholders sit in the cascade.
Here to discuss this name with you,
Wolfgang
T: +44 203 744 7003
www.sarria.co.uk