* Walsh has been CEO since IAG's formation in 2011
* Will be replaced by Iberia CEO Luis Gallego
* Gallego credited with returning Iberia to profit
* IAG shares up 1.9% (Adds investor comment)
By Sarah Young
LONDON, Jan 9 (Reuters) - Willie Walsh, who created British Airways parent IAG by dragging old-fashioned flag carriers into the modern age of budget flying, will step down in March to be replaced by Iberia boss Luis Gallego.
Walsh, who had announced in November that he intended to retire in the next two years, will be succeeded by the man credited with turning round IAG-owned Iberia since on March 26, IAG said on Thursday.
The appointment of Gallego, CEO of Iberia since 2014, meant there would be little change of direction at IAG, analysts said. But the Spaniard will face intense scrutiny as he takes over from one of the most high-profile figures in British industry over the past 20 years.
Irishman Walsh, a dealmaker who made his name standing up to unions and cutting costs, was BA chief executive before overseeing its merger with Iberia in 2011. That deal created an airline group that has since outperformed rivals Air France and Lufthansa while seeking to compete with budget disrupters Ryanair and easyJet.
IAG chairman Antonio Vazquez said that Gallego, 51, is the right candidate to replace the retiring Walsh, 58, and lead IAG in the next stage of its development.
Richard Buxton, of IAG shareholder Merian Global Investors, said Walsh's departure represented the end of an era.
"But as they say, all good things must come to an end. I know his successor is a good egg, otherwise the board would not have appointed him," Buxton said.
Market reaction was positive, with IAG shares gaining 1.9% to 630 pence by 1432 GMT.
As CEO of Iberia, Gallego cut the airline's losses by half in his first year in charge and in his second year restored profitability after six years of operating losses.
"Luis has successfully turned Iberia around in his years in charge and has much experience of the Willie Walsh/IAG approach," said Jonathan Wober, analyst at the CAPA-Centre for Aviation research company.
Gallego faces a number of challenges in his new role, not least the "flygskam", or "flight shame", movement that has shone a spotlight on aviation emissions and encourages people not to fly.
More specifically, IAG last year scaled back its three-year capacity growth plans, citing the competitive environment, and it has also been contending with reputational damage from pilot strikes at BA, which accounts for over half of group profit.
Merian Global's Buxton said he would like the new CEO to do more to improve labour relations between staff and management, adding that the top-15 investor is counting on the new IAG leadership to do more to knit its brands together.
Walsh, a former pilot, took on the unions and slashed costs first at Ireland's Aer Lingus, where he became CEO in 2001, and then at British Airways, earning him the nickname Slasher Walsh in an industry he once characterised as a "fight for survival".
It was at Aer Lingus where he formed the template for his strategy, benefiting from a front-row seat to the rapid expansion of budget rival Ryanair.
Walsh was much quicker than Air France-KLM and Lufthansa to embrace budget flying. IAG bought short-haul carrier Vueling in 2015 and set up long-haul, low-cost carrier Level in 2017.
Those strategies have helped to fuel success at IAG, shares of which are up 140% since 2011. Lufthansa shares, meanwhile, has remained flat over the period and Air France stock has declined by 29%.
Walsh also bought Aer Lingus in 2015 and IAG is in the process of a 1 billion euro ($1.1 billion) deal to buy Spain's Air Europa.
IAG said that Walsh would step down from his role and the board of IAG on March 26 before retiring on June 30, leaving Spanish executives dominant at the top of the Anglo-Spanish group. IAG's chairman is also Spanish, as is BA boss Alex Cruz. ($1 = 0.9001 euros)
Reporting by Sarah Young; additional reporting by Sinead Cruise, Clara-Laeila Laudette in Madrid and Noor Zainab Hussain in Bengaluru Editing by Susan Fenton and David Goodman