View from City Road: BA rights worthwhile for those who can wait

ICI, Royal Insurance and now a pounds 442m rights issue from British Airways. The appetite of the London stock market for underwriting must be near its natural limit, which does not augur well for share prices generally.

This is not the only point to be raised by the BA issue. Once again, the Stock Exchange is embarking on a probably futile attempt to find out how news of the cash-raising leaked out so heavily last Friday. It might also enquire, while it is at it, why BA shares outperformed the market by 8 per cent in the fortnight prior to the leaking of the rights news.

Setting worries about insider dealing and share price manipulation on one side, what are the merits of the BA cash-raising? Judging by the stock market's reaction yesterday, investors are keen enough. BA shares slipped 0.5p to 296.5p which is several pence above their theoretical ex- rights value even at last Friday's share price.

BA shares, apart from their recent mysterious levitation, have been under a dark cloud since last autumn. The problem has been falling passenger yields, or the amount of money that airlines can extract from each seat, which has stripped the profit out of resumed traffic growth.

Premium business travellers have dwindled and price discounting has spread in the wake of large increases in airline capacity. New aircraft fleets ordered at the peak have landed at just the wrong moment.

The vicious impact of declining yields can be seen from BA's 1992/3 results. As a 1 percentage point movement in yields is worth pounds 45m to profits at BA, a 5.7 per cent fall last year is the main reason behind a 35 per cent underlying fall in BA's pre-tax profits to pounds 185m. If BA had not cut costs by significantly more than its pounds 150m target last year it might well have joined its fellow Iata members in their dollars 5bn global loss.

BA has not helped its cause by adding 14 per cent more capacity this summer. This, even assuming BA can fill the seats, not only hits yields but it has led to a pounds 541m cash outflow last year even before spending a further pounds 574m on strategic stakes in the likes of USAir, Quantas and TAT. Hence the rights issue which cuts the proportion of debt to BA's equity from a towering 150 per cent to a still sky-high 100 per cent.

Another cash outflow is planned this year, but by 1994/5 the new aircraft spending tap is turned off. Yields could then be set to rise, profits to power ahead, and cash to flow back. A historical p/e of 12 and a dividend yield of 4.4 per cent are not an expensive rating now. Looking ahead to 1995 the rating is cheap. Despite likely delays in the months ahead BA shares should start to climb again, which means shareholders wanting to put more cash into shares should take up their rights.