The decision to allow the payment of the second I£50 million ($81.5 million) tranche of the total state aid package of I£175 million last December came as a timely Christmas present for the Irish flag carrier. But ultimately critics of the decision must accept that the lobbying powers of the Irish government in Brussels are limited compared to the blatant French bullying of the Commission that brought Air France its bloated $4 billion state capital injection.
The Commission's decision, published in the Official Journal of the European Communities three months after the event, certainly fails to stick to the letter of the original state aid ruling. But the Commission appears to have concluded it should remain within the spirit of a process aimed at returning the carrier to commercial viability. It justifies this by highlighting the progress in the core airline operation where it states 'the airline business has improved its profitability ahead of the programme . . . As the group is to focus on the air transport activity, this trend should be considered encouraging, and indicate a successful completion of the restructuring programme'.
The situation at maintenance subsidiary Team, which somewhat unfairly bore the brunt of the blame from management for a derogation being needed, was not the only blot on the first 12 months of the two-year restructuring programme. Two other main factors - higher than expected restructuring costs and failure to dispose of the group's main non-core assets, chiefly the Copthorne hotel chain - led to exceptional items totalling I£139.2 million in the 21-month accounts ending 31 December 1994 and a massive 353 per cent gearing (although this figure had dropped from 688 per cent in March 1993). Interest payments totalled I£60.7 million in 1994.
Put into context, Team's poor performance - with a pre-tax loss of I£27.9 million in the 21-month period - certainly reduced the impact of the airline's pre-tax profit of I£40.9 million for the same period. But in the exceptional items, which pulled the group result into the red with an after-tax loss of I£129.9 million, the maintenance subsidiary accounts for just I£22.07 million - less than 16 per cent of the write-offs. And over half of this figure is made up of a 100 per cent overrun on the redundacy programme.
Not surprisingly, Aer Lingus group chief executive Gary McGann is quick to commend the thinking of the Commission in granting the derogation, which he says reflects an understanding that Team's performance was overshadowing the achievements at the airline. He further makes the point that 'as we were applying for the second tranche Team wasn't even back at work,' referring to the maintenance subsidiary's three week period under examinership (the Irish equivalent of Chapter 11) in October last year. The initial refusal by the unions in mid-1994 to accept new work conditions was always going to spell problems for executive chairman Bernie Cahill's restructuring plan - Strategy for the Future - and a deal was only struck after the workforce realised the alternative was closure. Now Team must repair the damage it has done to its reputation and win back the third party work it has lost, in a market that is suffering 30 per cent overcapacity.
Certainly the restructuring has gone a lot more smoothly at the core airline, with the carrier achieving its I£36 million share of the total group annual savings of I£50 million, envisaged under Cahill's plan, ahead of schedule. The reduction in costs can mainly be attributed to the 1,000 voluntary redundancies, a change in work practices and rostering, and a reappraisal of the carrier's route structure, fleet and schedules. McGann says the staff cuts were in place by the end of March 1995, although the accounts show less than 500 jobs had gone by the end of 1994.
Unfortunately, management are loath to give a breakdown of the annual savings and the picture is complicated by the 21-month reporting period - shifting Aer Lingus' year end from March to December - which covers two summer scheduling periods and only one winter. However, an endorsement from the Commission in the Official Journal, backed by an independent audit from Coopers & Lybrand, makes the accounts more credible.
Certainly the turnaround in the airline's unprofitable North Atlantic operations has been central to its success. 'The biggest single contributor has been the A330. Its economics are so good compared to the old B747[-100S] which incurred some very heavy maintenance charges. The aircraft are more expensive to own but maintenance charges are much reduced and fuel consumption is about half that of the 747,' explains commercial director Bob Challens.
The removal of the Shannon stopover on the Dublin-New York route from March 1994, and the opportunity provided by the arrival of the three A330s from mid-1994 to upgrade the business class product, have also been major contributing factors to a 24 per cent growth in traffic to and from the US in 1994. Broken down, traffic on the daily Dublin-New York service grew by more than 40 per cent reaching average load factors of 80 per cent.
The daily Shannon-New York service saw solid growth of 10 per cent with average loads of 72 per cent. The carrier has reportedly also enjoyed unprecedented growth on its Dublin-Shannon-Boston route, with an increase of 26 per cent and average 81 per cent load factors for 1994. The high load factors seem impressive but the nature of the Irish market - with a total population of just 3 million - makes Aer Lingus a relatively low yield carrier across the Atlantic with a high proportion of leisure and VFR traffic. It is hoping to get board approval to lease in a fourth A330 this year.
Aer Lingus is also claiming a return to profit on its major European trunk route between Dublin and London/Heathrow, following a 20 per cent cut in capacity. 'We have walked away from the slavish dedication to the defence of market share as an end in itself,' says McGann, though he refuses to comment on the exact level of profitability of this and other individual routes. Cahill, however, was reported last December as claiming the route would produce profits of I£2 million in 1994 compared to a 1992 loss of I£12 million.
The other European trunk routes are termed by Challens as a 'profitable route group and the one we are happiest with in the next year or two', leaving the regional routes to the UK as seemingly the carrier's only headache. Here, the airline's strategic shift has landed it in yet more controversy - albeit a furore stoked by Aer Lingus' main competitor on those routes, low-cost Irish independent, Ryanair.
McGann is the first to admit that competing against Ryanair's fleet of 11 B737s with turboprops did not help the losses on the UK regional routes. 'Clearly turboprops on some of the [regional] trunk routes was an inferior product.' As a result the carrier began introducing three BAe 146-300s on Dublin services to Birmingham, Glasgow, Manchester, Edinburgh and Bristol from April. The jets will replace Fokker 50s on these routes, explains Challens, and in order to comply with the state aid ruling limiting the its short-haul fleet to 26 aircraft, Aer Lingus is looking to dispose of four grounded Saab 340s.
But the carrier's move came under attack from Ryanair, which has lodged a complaint with the Commission alleging that the addition of the BAe146s broke the fleet and capacity limitations imposed by the state aid ruling. Indeed, the Commission had already expressed its concerns over this strategy in the Official Journal: 'The replacement of small turboprop aircraft by jets on UK commercial routes could give rise to concerns as to whether the increase in capacity offered is appropriate.'
The report adds that Aer Lingus will need to demonstrate that 'the aid it has received is not being used to subsidise routes . . . which in all likelihood will not become profitable in the foreseeable future.' Challens denies the jets will take summer capacity above the levels set in the state aid ruling, 'not even near,' he adds. The Commission put its limits on capacity on Ireland-UK routes up by some 10 per cent for 1995.
The Commission does however approve of the UK regional strategy to feed transatlantic points with the jets providing what McGann terms a high quality, seamless product.
Challens stresses that Aer Lingus is not going head-to-head with Ryanair in the UK provincial market and indeed the flag carrier would have trouble matching its no-frills rival's low fare structure, which drops prices as low as $78 return in the summer schedule, while staying within the confines of the state aid ruling. 'We have a very firm view of the pitching point, which is the top 75 to 80 per cent of the market. We believe we can command a premium in any market against most competitors,' says Challens.
Undoubtedly fortunate to obtain the derogation, Aer Lingus' management still has a lot to do before it can expect Commission clearance for the final I£50 million tranche of the I£175 million state aid package due by December 1995. 'We are sanguine about what we have achieved, but we've got a huge job to do yet,' admits McGann, adding that he wants the final tranche earlier than December.
Not least, the Commission requires a report and business plan for Team by the end of June. McGann says the maintenance subsidiary is already 'in shape to continue trading sensibly' after some 300 voluntary redundancies, but adds that together with the engine repair subsidiary, Air Motive, 'it would make sense to either find a strategic partner or an owner, if the shape was right.' He stresses, however, that neither are 'disposable at this point in time.' But Team is still having to compete in a saturated market, although on the positive side, the new labour agreements include an undertaking not to resort to industrial action during the restructuring.
But the management still has a number of non-core subsidiaries to dispose of, including the Copthorne hotel chain - the group's main non-core asset. In April, Aer Lingus raised I£11.5 million through a management buy-out at Parc group, the personnel and management services subsidiary, and in early May was 'well advanced in our sale of Irish Helicopters,' says McGann. The disposal of the Copthorne chain, valued in excess of I£200 million, postponed last year because of a soft property market and what McGann terms a 'misread of our for sale sign as a fire sale sign', remains the priority. McGann maintains he will sell the chain by March 1996.
Indeed, the proceeds from Copthorne will be one of 'the key factors' in reducing the carrier's excessive gearing to 'well below 100 per cent.' Other factors aimed at reducing the debt burden include a positive cashflow from operations, the final state aid tranche and the I£30-40 million in 'gearing benefit' McGann expects to receive from the other non-core disposals this year.
Elsewhere, concerns have been expressed about the number of senior staff taking advantage of the voluntary redundancy programme, which led to restructuring cost overruns in both Team and the airline. McGann prefers to play up the future payback of lower salary costs later on, but the loss of airline experience versus lower costs is an imponderable. Indeed, McGann's six-strong management team contains three non-airline executives, including McGann himself.
Aer Lingus is starting to size up potential alliance partners, but Challens stresses any link will be tactical rather than strategic. 'We would initially have a number of tactical alliances in various geographical areas rather than being dominated as a junior partner in one major alliance.' This could involve an extension of the block seat arrangement the carrier has with Sabena on the Dublin-Brussels route to other airlines in Europe. Aer Lingus is also looking toward the US and both Delta Air Lines (the only US carrier to serve Ireland) and TWA have been mentioned.
The carrier is also banking on the economic benefits of the 'peace dividend', says McGann. The ceasefire in Northern Ireland is already having a marked effect on tourism and business interest is also picking up. With Ireland enjoying the highest GDP growth in Europe for the second year running, the carrier also believes the expected growth in leisure traffic should be balanced to some extent by an increase in higher yield business class passengers.
The likelihood of more labour unrest spoiling 1995 targets is remote, but there is no doubt the carrier will continue to sit uncomfortably next to its low-cost rival Ryanair. Even if non-core asset disposals continue and traffic growth remains solid, Aer Lingus will struggle to meet interest payments, on top of repayment of short-term debt and payments to trade creditors totalling I£116 million, this year. As the Commission suggests in its derogation decision: '1995 will be decisive in confirming that Aer Lingus will continue to move in the right direction'.
Source: Airline Business
