Stock market listing will demand new kind of discipline from airline, writes Emmet Oliver

The founder of Southwest Airlines, Herb Kelleher, once famously said: "If the Wright brothers were alive today, Wilbur would have to fire Orville to reduce costs."

Kelleher would certainly have no difficulties showing Orville the door. At Southwest the emphasis on cost control is legendary.

Southwest is the only US carrier to be profitable every year since 1972. Consequently the airline is the darling of equity markets in the US. It now boasts a market capitalisation of $14.3 billion (€11.7 billion), more than twice the size of British Airways. It has an operating margin of 10.8 per cent and its quarterly revenue grows on average by 20 per cent year-on-year.

Based on this performance, its shares have risen 40 per cent since a low back in September.

Southwest is not unique. Jetblue, another more recently established US low-cost carrier, has managed average growth in revenue of 33.8 per cent.

This is the demanding world Aer Lingus will be stepping into in June or, more likely, September.

Market demands are unambiguous when it comes to airline stocks. Strong aggressive revenue growth is expected, with margins for low-cost carriers hovering between 10.8 per cent (Southwest) and 22.7 per cent (Ryanair). Even traditional carriers like British Airways are aiming for a 10 per cent margin.

Few of the fast-growing European or US carriers pay dividends, including Ryanair, so what drives the share price is strong earnings growth. That is probably to the advantage of Aer Lingus - which hasn't paid a dividend in years.

Aer Lingus, while not strictly a low-cost carrier, has in recent years been among the higher margin ones. In 2004, under Willie Walsh, it managed a very respectable margin of 11.8 per cent, though this dropped to 8.2 per cent last year.

The current chief executive, Dermot Mannion, has warned that it must try to get back into double figures in 2006 if possible. The operating margin figure is a crucial one - it shows how successful a company's management has been in generating income from the operation of the business.

If a flotation goes ahead in June or September, the kind of discipline other airline stocks have been enduring over recent years will be required of Aer Lingus.

The 2005 results published a few weeks ago by the airline are described by analysts as reasonably credible but a closer look at the figures suggest Aer Lingus will still have some convincing to do when it begins its investment roadshow in the next few months. The simple problem, as revealed in the 2005 figures, is that Aer Lingus is carrying more people but for less.

Passengers numbers went up 2005 by 15.6 per cent to eight million, but the airline's turnover was down to €883 million from €906 million, a drop of 2.6 per cent. The competitive environment is what is driving this.

While Aer Lingus had more people in their new Airbus seats in 2005, those people were paying less. The average fare on short-haul routes (UK and Europe) dropped 16 per cent to €66.81, while the average fare on the US routes dropped 4.7 per cent to €240.78.

These figures indicate that the soft underbelly of the Aer Lingus commercial offering is short-haul. This is where uncompromising players like EasyJet and Ryanair are lurking. Dermot Mannion says he wants to boost shorthaul capacity by 60 per cent, but with fares coming under such pressure, how much of a boost to the bottom line will this produce?

While the future growth story of Aer Lingus is likely to come from long-haul traffic, at the moment the contribution from short-haul routes is significant. At the company's results presentation in March, Mr Mannion revealed that short-haul is chipping in about 60 per cent of profits, with the rest from long-haul (primarily to the US).

With Ryanair trying to deploy extra capacity into Dublin, the short-haul battle is not going to get any easier. Aer Lingus sensibly renewed its short-haul fleet two years ago and the new Airbus A320s are good workhorses which don't gobble up excessive amounts of fuel and give the airline extra capacity.

Whatever about short haul, long haul also presents its own unique set of problems. While Aer Lingus is desperate to grow this part of its business, as part of Mr Mannion's "twin track strategy", it has proven difficult, even with falling fares. Last year Aer Lingus carried 1.2 million passengers to cities like New York, Boston, Los Angeles and Chicago, but this figure was static.

As one fund manager told this reporter: "I am not too interested in where Aer Lingus gets its passengers from now, I am interested in where it will be getting them in future."

While opening new routes to the likes of San Francisco, San Jose and San Diego on the west coast, and possibly Philadelphia and Miami on the east coast, may boost the numbers, none of these new destinations are going to produce anything like the revenue returns from a Dublin-JFK or a Dublin-Chicago O'Hare.

While the shares, when they float, are likely to be be cheap, the markets will want to see a sign of a developing long-haul strategy pretty quickly. There is another problem in this area - the US bilateral. This confines Aer Lingus to just five airports - New York, Los Angeles, Boston, Chicago and Washington DC - with the airline deciding to scrap Washington two years ago. As part of EU-US talks, such bilaterals are meant to go and Aer Lingus will be allowed to fly where it wants, but the talks have been painfully slow and Aer Lingus is still restricted.

But come June or September, the real challenge, of meeting the endless demands of national and international fund managers, will just be beginning.