International Airlines Group (IAG) is focusing its attention on returning Iberia to profitability and integrating BMI, once regulatory hurdles are cleared and the acquisition is approved.

“Our two operating companies (British Airways and Iberia) are in very different conditions,“ says IAG CEO Willie Walsh. While BA achieved a £518 million ($827.4 million) operating profit, (up £321 million) in fiscal 2011, Iberia recorded a €98 million ($131.9 million) loss, €70 million worse than a year earlier. At BA, revenues increased 17% while Iberia’s grew only 1.4%.

“Iberia has a unit revenue challenge in the business,” Walsh says. “It has been suffering from the weak economic environment in Spain and structural costs that have to be tackled.” Unit revenues late last year were 13% lower than their peak at the end of 2008, and IAG has little hope they will return to that point any time soon. “This requires major surgery,” Walsh says.

The group’s answer is Iberia Express, the new lower-cost platform that is planned to be the main feeder for the Madrid hub. IAG expects the airline to start service with four Airbus A320s in the summer schedule, increasing the fleet to 13 aircraft by year-end and to 40 by the end of 2015. Once the new operation is fully rolled out, IAG expects Iberia’s results to reflect a gain of more than €100 million.

Walsh admits that “we are facing stubborn resistance” from the Sepla pilot union, which has been asked to agree to significant concessions. But he warns that “there is no way Iberia can continue to operate as it has in the past.”

Iberia CEO Raphael Sanchez says, “We have a problem with pilots accepting realities, but over time reality will prevail.” Cockpit crews have staged 12 days of strikes, each day costing about €3 million. Forty-five percent of the improvement in operating results from Iberia Express is expected to come from flight crews, 25% from handling services and operations, 25% from overhead savings and 5% from improved asset turns.

For the BMI integration, Walsh expects to receive regulatory clearance by March 16 at the earliest. The airline, a Lufthansa group subsidiary, is being acquired by IAG to be integrated into British Airways pending antitrust approvals.

Walsh says IAG does not have any plans for further acquisitions right now. “You can ignore anything you can read in the press,” he told analysts in a conference call. However, IAG is closely watching what could happen in the U.S. and with its long-standing partner, American Airlines. The carrier’s Chapter 11 filing has not had “any impact on us whatsoever,” Walsh says. He believes that “there is room for further consolidation in the U.S.” and a combination of American and Delta “would be a fantastic entity.” He cautions however that there would be significant hurdles to gain regulatory approval. A merger of American with US Airways would be “potentially a positive development,” but he believes that American would want to control the new carrier. Walsh points out that “we are familiar with all of the players” and are being kept well informed by American about its plans.

Many of the potential combinations would be “very positive” for IAG, and some would have disadvantages, Walsh believes.

In its first year since the merger, IAG posted a €485 million operating profit on €16.3 billion in sales. The group was faced with a 29.7% increase in fuel costs totaling €5.06 billion. IAG expects fuel expenses to rise by at least €1 billion in 2012.

Walsh says that the effects of higher fuel costs, strike disruptions at Iberia and the weak European market may reduce operating profits in the first half of 2012, but the cost pressures are likely to be less intense in the second half.

IAG has beaten its synergy targets for 2011 by €64 million. It originally budgeted €72 million, but reached €134 million in the form of cost savings and increased revenues.

More broadly, Walsh believes that “the industry is transforming in a positive direction” with consolidation continuing in the form of market exits and takeovers. “There is a very good capacity discipline in the industry; everybody has scaled back plans.” IAG itself planned to grow 2.5% in 2012, but will now offer only 1.7% more capacity. The group has taken delivery of three Boeing 777-300ERs and phased out one Airbus A340-300 and one A319. In the summer, it will keep on the ground one BA 747-400 that was due to be active again this winter. A further two A340-300s will leave the Iberia fleet.