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Aer Lingus CFO on helping to turn around the fortunes at Ireland's flag carrier

Aer Lingus CFO on helping to turn around the fortunes at Ireland's flag carrier

It's not the easiest time to be a chief financial officer of an airline business. Increased incidence of natural disasters, volatile fuel prices, a possible double-dip recession and falling passenger numbers have all combined to severely dent most airlines' profits and prospects, so to join the board of an airline at the time of one of its worst financial years is a job only for the very experienced.

But then Andrew Macfarlane, CFO of Aer Lingus, has solved messier financial dilemmas before now. And it's a good job he has because when he joined Ireland's flag carrier in 2009 as interim finance chief, the business was facing an operating loss of nearly €90 million on revenues of around €1.2 billion, and passenger numbers were falling fast.

With a new management team on board (of which Macfarlane was a member) the executives tore up the old strategy of competing with its main domestic rival -- the much younger and cheaper upstart Ryanair -- and started work on a new three year transformation programme dubbed Greenfield.

The strategy involves overhauling the airline's commercial model and cutting €97 million out of the cost base. So far the CFO has removed around €80 million and he's "confident we'll get the balance of it this year".

The board is repositioning Aer Lingus somewhere between the low-cost, no-frills airlines and the higher end carriers. 'Value carrier' is a term Macfarlane doesn't particularly like, but it is a philosophy the company is pursuing with determination.

To underpin the repositioning of Aer Lingus as a value carrier, the company is also ditching its former marketing plan of pushing Aer Lingus as a point-to-point carrier and have been marketing the airline's attributes as a 'connected' airline.

"One of the changes made to strategy was to emphasise our connectedness. Now we say our mission is to connect Ireland to the world and the world to Ireland," Macfarlane explains.

A gentle lift-off

The strategy appears to be working. Passenger number rose by 2.1 percent in the third quarter last year with full year volumes rising 0.2 percent on the previous year. Retail revenue per passenger also increased by 6.1 percent in the third quarter. Admittedly, traffic still isn't anywhere near the highs Aer Lingus achieved before the company got into financial difficultly and the global recession, but this is in the context of a fall in air travel both around the world and at the airline's hub in Dublin. In 2010, for example, Dublin Airport handled over 18.4 million passengers, a 10 percent decrease on 2009 levels.

Macfarlane admits that the growth is "very small" but he is upbeat on yield. "Yield has been tracking ahead of previous years and that theme has continued. What we have said is that we'll be demand-led and we'll not go chasing volume," he says.

"We'll match supply to demand and if demand is flat, we'll keep our capacity flat and we'll get smarter in the way in which we manage yield," he says.

One of the first places Macfarlane had to start with when cutting costs was in remuneration and staff benefits. Most of the workforce took a 10 percent pay cut and salaries have been frozen for three years. It's worth noting that it wasn't only the workers who took a pay cut. The CFO took a larger than 10 percent cut in salary; something he had never done in his career.

"It's very important that we take the same medicine. Otherwise you don't have the moral authority, do you?" he asks rhetorically.

Whether the move represents a sea change among finance chiefs or is simply an isolated case in response to a business need will be interesting to watch. On the burning issue of executive pay and government moves to crack down on it, however, Macfarlane doesn't think that legislation is the right answer.

"If shareholders don't like what's happening they already have the levers. There's nothing to stop three or four of the biggest shareholders in any plc calling in the chairman of the remuneration committee and saying 'we don't like what's happening'.

"The tools are there and things would get sorted best using the existing levers."

Macfarlane, for one, would like to see greater shareholder engagement. And you can't blame him. Despite all the work he and his fellow board members have done in replotting the company's flight path, its share price has not responded positively.

Share issues

It's a dilemma that concerns him, but one of the reasons for the poor response may be the identity of two of Aer Lingus's major shareholders. The Irish government retains a 25 percent stake in the former state-owned business, while arch rival Ryanair holds a 29.8 percent stake. Investors are clearly cautious about what these shareholders' plans are for the business.

Irish ministers, of course, have had a few other preoccupations of late, and despite the Irish economy returning to modest growth last year following the banking crisis and a multi-million-euro bailout, the economic recovery is fragile and growth forecasts have been downgraded for 2012.

CEO Christoph Mueller has said he wants the two parties to sell their combined 55 percent shareholding as a single package because it would help Aer Lingus boost its share price by reducing analyst uncertainty. His CFO shares the sentiment.

"We hope and believe that they [the Irish government] will want to sell that [stake] and we hope we can influence the disposition of that stake in the way that will be supportive of the future development of the business. The Irish government needs to raise money so we have challenges at that level," Macfarlane explains.

Given the harsh economic backdrop against which Aer Lingus has been trading, its performance has been robust. In its third-quarter statement in November, the airline reported a 19.4 percent rise in operating profit to €94.6 million, up from €79.2 million the previous year.

The board said it was on schedule to report full-year 2011 operating profit at the upper end of market forecasts. Analysts expect Aer Lingus to report full-year, pre-tax profits of around €40 million when the airline reports at the end of February.

Macfarlane's role in the company's rebound should not be underestimated. His record as a finance chief at previous employers is testament to his keen understanding of how to not only return a business to profit, but also how to reinstate trust and respect in a company.

At business services group Rentokil Initial, the chief executive Alan Brown credited then CFO Macfarlane for his work in securing robust credit facilities after a few rocky years.

But it was at Land Securities where Macfarlane really made his mark, modernising the property giant into a more dynamic and respected business. He implemented a £3.2 billion debt restructuring programme, which saved the company around £25 million in annual interest costs and provided the business with increased flexibility to take advantage of its £6.2 billion asset base.

He left Land Securities with an improved financing future thanks to the upgrading of the company's credit rating to AA. The company's report and accounts won awards, as did Macfarlane, who was praised for a newfound openness and disclosure which impressed investors.

Macfarlane is hoping some of that magic will rub off on Aer Lingus's share price but he has a few challenges to deal with first.

Despite the uncertain macro-economic outlook affecting Ireland and its customer base there, there's little room for manoeuvre within the organisation once Macfarlane has cut the remainder of his targeted costs. With margins typically low in the airline business -- around five percent on average -- Aer Lingus has to work hard to attain its four percent margins.

The airline's cost base breaks down into roughly four equal chunks: a quarter fuel ("and there's very little we can do about the price of fuel"); a quarter airport charges -- again mostly regulated and "very little up for negotiation"; a quarter staff, and the final quarter -- "everything else".

It's on the "everything else" that the finance chief is focusing, because an extra two miles per gallon is "worth about €6 million a year to us", he explains.

Where the CFO is also hoping to make savings is in more efficiency. The company has set up a programme to improve aircraft fuel efficiency, addressing things like on?board weight by changing the carts and trolleys for ones made out of lighter metal, among other initiatives such as optimising flight settings for take-off and taxi-ing on single engines.

Macfarlane also uses a fuel hedging programme designed not so much "to beat the market but to give price predictability to our commercial team". He will continue to challenge headcount and productivity measures to ensure the airline's costs are as light as possible in the hope that while the internal battle goes on, external pressures will lighten and help push up the company's share price to what Macfarlane and his board members believe shows the true value of a transformed airline.

CV: Andrew Macfarlane

2009-present: CFO,

Aer Lingus Group

2005-2009: Group CFO, Rentokil Initial

2003-2006: Non-executive director, audit committee chair, Invensys

2001-2005: Group Finance Director, Land Securities Group

1997-2001: CFO Bass Hotels & Resorts (Holiday Inn, Intercontinental etc) Bass

1987-1997: Partner, Corporate Advisory, Ernst & Young

Why cash matters

The nature of the airline business means that finance chiefs try to ensure their company has a strong cash reserve to tap into should natural disasters or political upheaval like the Arab Spring protests of 2011 restrict air travel.

Its third-quarter trading update showed that Aer Lingus was in a strong cash position, with net cash of €354.6 million once debt of €572.7 million is taken away from the €927.3 million cash reserves.

Aer Lingus CFO Andrew Macfarlane says that as an airline you'd typically want at least 25 percent of revenue in cash available. It's not an easy task to juggle either as airlines are prone to peaks and troughs.

"The problem that we have between peak and trough in the year is that our working cash is something like €150 million," Macfarlane explains.

With the industry prone to shocks, "you need a good cash buffer against something happening -- weather delays, fuel price spikes that sort of stuff", Macfarlane explains.

Stockpiling cash is an increasing focus for airlines too. From the 1970s to around 2008, peaks and troughs in the industry were very regular -- five years of profits, five years of losses -- but nowadays change is sudden. "The amplitude is increasing. When the business turns, it can turn very fast," he says.

It is at the point when the business turns that the board has to act quickly and implement a clear restructuring strategy.

"You're turning from profits into loss then you have to incur a big restructuring cost. Then potentially you have two or three years of losses and that's the time when the banks aren't going to extend new facilities to you because you're loss-making so you have to fund the losses out of the cash you had when you went into the downturn," Macfarlane explains.

What further complicates matters in the airline industry is the huge aircraft order books for replacing and rolling over the fleet to make sure the company has modern, fuel-efficient aircraft.

"We have something like €900 million worth of aircraft on order at various times in the decade. Where you could get into serious problems if the business turns down and you've misjudged your order book but you still have to write out a cheque to Airbus," says Macfarlane.

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