Aer Lingus: setting a course for a new destination

Airline Analyst Joe Gill explores Aer Lingus’ future prospects and how new CEO Christopher Mueller made his mark on the national carrier

Aer Lingus’ equity investors could be forgiven for pressing the buttons marked “cynicism” and “scepticism” when hearing of another strategy presentation. Their investment has been whittled away since 2006, both by external and internal factors. However, last week the airline’s recently appointed CEO, Christoph Mueller, set out his vision for the company in a detailed briefing that provided clarity and direction. Executing this plan will be the key to ensuring Aer Lingus’ future viability and success.
The strategy is threefold. Step 1: batten down the hatches. Having extensively reviewed the business, Mr. Mueller is now focussed on stabilising the group’s finances and protecting the net cash balances that remain in the business. To this end, deferred deliveries and the winding down of expansion plans together with a cost cutting programme are the central focus.
We now know Aer Lingus’ year-end net cash was over €330m. The owned fleet is worth €684m and lease debt is €493m. Despite shelling out almost €500m in the past year through capital expenditure, redundancy payments and operating losses, this balance sheet remains, by any definition, strong. To protect this position a restructuring programme has been undertaken that will yield savings of €58m in 2010 and reach €97m by 2012. This will help Aer Lingus compete on its chosen battlefield – Ireland.
Step 2: fortress Ireland. Ambitions to develop an international long-haul or short-haul footprint have been effectively shelved. Rather, Aer Lingus is set to make Ireland its core operating environment. Belfast, Cork, Dublin and Shannon are now the key bases from which short-haul services will work, with a particular focus on Heathrow where additional slots have been secured as well as more being sought.
Long-haul services have been scaled back aggressively to support its three key US gateways (Boston, New York and Chicago) where partners, jetBlue and United, can feed traffic across the US.
From Ireland, Aer Lingus will leverage its brand and the additional services it offers to passengers such as allocated seating, frequent flyer programmes and central airports. This marks one of the most radical deviations from the previous business model. Instead of trying to compete with true low cost carriers on fares, Aer Lingus will attempt to extract unit revenues above those of true low cost carriers like Ryanair.
The company will use its yield management and ancillary revenue resources to support revenue formation while its capacity is rattled back. Short-haul volume increased 1% last year, while its long-haul business fell a staggering 20%. To augment its focus on Ireland the group has agreed a revenue sharing deal with the regional carrier Aer Arann that provides services on thin UK provincial routes into Cork and Dublin. Aer Arann, along with the Aer Lingus short-haul network, will be used to create two-way feed for long haul services into Dublin.
Step 3: flirtation. Assuming steps 1 and 2 work, Aer Lingus will have a cleaned-up cost base, a solid balance sheet, a defined Irish footprint, and cash flows stabilised by a return to operating profit in 2011. Step 3 is to effect an unalloyed seduction of one of the three global alliances.
Aer Lingus already plays with Skyteam (via Amsterdam with KLM), Oneworld (via Heathrow with British Airways) and STAR (via United and indirectly jetBlue). Each offers Aer Lingus global connectivity. All three have their own internal dynamics at work toward integration and it is likely that Aer Lingus will be forced to choose one over the next year. It is hard to believe OneWorld is not in pole position given that Aer Lingus’ short haul spine swivels around Heathrow. Giving Aer Lingus passengers access to OneWorld frequent flyer programmes would surely embellish yields. Furthermore, if the Conservatives win the next UK election and bin plans for a third Heathrow runway, that will make the Aer Lingus slot portfolio of increased attraction to OneWorld players such as British Airways and Iberia.
It is likely that both trade union and political shareholders will enthusiastically endorse Aer Lingus’ efforts as it could provide a very real alternative to Ryanair which both – not to put too fine a point on it – despise.
The success of the plan depends very much on Mr. Mueller’s resolve. He has already replaced investment advisors, shuffled the management team and carried an extensive change programme without taking a strike. If he executes this plan, credit should be allocated where due. But what are the risks?
Some investors may struggle with the notion of positive yield generation. Yields are likely to have risen last year as capacity extraction by Aer Lingus and other airlines combined with a bottoming economy to provide a much needed boost for revenues. However, building a strategy around growing yields in a structural way is more challenging. At a minimum it implies capacity growth is sharply curtailed for the foreseeable future. It also assumes a sustained attack by a lower cost airline can be avoided.
The company promises more detailed data disclosure with its final year results for 2009. The roll-out of this plan will therefore be highly transparent, meaning that its success or failure should be instantly visible. Mr. Mueller is willingly opening the books, which itself is a measure of his confidence in the future.
If we assume a return to profits in 2011, and believe cash balances can be protected over the next year, then the outlook for the airline looks promising. Any further weakness in spot oil could also spice up the numbers as just 16% of the company’s fuel requirements for 2010 are hedged at $762 per ton.
While prospects are certainly improving at Aer Lingus, to say anything more requires confirmation that the numbers are unfolding according to plan.