Healthier airline must cut its costs to grow

HEADLINE figures of a 130 per cent rise in pre tax profits to £41 million at Aer Lingus do not tell the full story. Analysis of the group's latest accounts is complicated by once off charges against profits in 1995 and once off gains in 1996 as well as its exit from a number of non core activities between 1995 and 1996.

The bottom line is that the group was indeed healthier at the end of 1996, both in profit terms and in financial strength. But core air transport operations remained under pressure, with a fall in operating profits despite higher sales. In competitive markets, operating margins on core air transport fell from 6 per cent to 5.5 per cent with operating profits down from £43.6 million to £42.2 million.

When exceptional charges and gains and discontinued operations are stripped out, pretax profits at Aer Lingus rose to £40.5 million from £19.8 million. Some £19 million of this £20.7 million turnaround came from lower net interest costs as a result of the Government cash injection which reduced borrowings. Meanwhile, asset sales generated interest earnings. Lower losses at the group's subsidiaries helped the 1996 outcome, though losses at TEAM rose again.

While debt repayments and cash holdings will ensure lower net interest charges in the future and give the group financial flexibility, the sharp boost to profits from the drop in the charge was effectively a once off factor in 1996. The question then is where future profit growth will come from.

The concern must be about the core air transport area where, despite buoyant markets, operating profits fell. How will Aer Lingus raise its return on sales from the current 5.5 per cent level to the target 8 per cent?

Growth in costs is one area that must be tackled. Developing new business is another area which may be achieved by finding a partner/partners who can add financial backing as well as opening a wider network of routes for the airline.

Costs grew faster than revenue in 1996. That is not sustainable if profits growth is the target. As well as a high cost base, a major issue this year will be pay relativity claims following the 5 per cent increase paid to pilots.

Chief executive, Mr Gary McGann said management and unions were trying to develop a more non confrontational approach to solving difficulties. Staff must be rewarded fairly but, because this can only happen within the constraints of revenue generated, productivity and flexibility are likely to be major issues.

On a strategic alliance, which could see the sale of equity in Aer Lingus to one or more international partners, the group will produce a plan for the Government by the end of this year. Aer Lingus has had discussions with a number of potential partners.

Strategic alliances need not involve the transfer of equity - it could involve feeding its passengers on to the routes of its partner and vice versa. But, because of its size and the dangers when the current business cycle slows, Mr McGann favours equity participation by a partner and partners.

Overall, Aer Lingus was in a healthier financial state at the end of 1996 with a 16.7 per cent return on shareholders' funds. But 1996 was a good year in the cyclical airline industry and the national airline still has work to do to maintain profitability in leaner years.