11-Feb-2016 4:30 PM

Finnair: back in profit and set to reap benefits of A350-led fleet upgrade and labour productivity

Analysis

Finnair returned to profit in 2015, thanks in no small part to lower fuel prices. This was only its third positive result since before the global financial crisis, and it continues to lag the industry in its profitability. Nevertheless, its returns to profit and to both capacity and revenue growth are important markers on its financial progress. Perhaps more significantly, in a sector accustomed to thin margins where liquidity and balance sheet strength are vital, Finnair has moved into a net cash position.

However, Finnair's revenue was still below where it was in 2013, and its operational margin lagged far behind the rest of the global airline industry, which was collectively reaching an estimated new peak margin in 2015.

Finnair's return to profit and revenue growth is welcome, but it still has much to do. CEO Pekka Vauramo recognises this, saying, "we will now look to accelerate our profitable growth". Strong labour productivity improvements in recent years have provided a good basis for this. Finnair's fleet improvement programme, led by A350 deliveries that started in 2015 and will continue to 2023, should also be beneficial.

Summary

Finnair returned to profit in 2015, with a net profit of EUR90 million, compared to a loss of EUR83 million in 2014.
The operational result improved from a loss of EUR37 million in 2014 to a profit of EUR24 million in 2015.
Finnair's revenue grew by 1.7% to EUR2,324 million in 2015.
The airline achieved a net cash position of EUR362 million at the end of 2015, compared to net debt of EUR2 million in 2014.
Finnair's fleet transformation, led by the introduction of the A350, is expected to lower unit operating costs and improve efficiency.
The airline plans to accelerate its profitable growth and increase capacity and revenue in 2016, supported by lower fuel prices.

2015: back in profit; 4Q2015 is fifth successive quarter of improvement

Finnair's net result returned to profit in 2015, turning around a loss of EUR83 million in 2014 to achieve a positive result of EUR90 million. The operational result, which excludes interest, tax and non-recurring items and more closely reflects the underlying business performance, improved from a loss of EUR37 million in 2014 to a profit of EUR24 million in 2015. Revenue grew by 1.7% to EUR2,324 million and the operating margin gained 2.6ppts to 1.0%.

The 4Q2015 operational result was just above breakeven, returning the traditionally weak winter quarter to profit after a EUR9m operational loss in 4Q2014, and extending its year on year profit improvement to five consecutive quarters.

Finnair financial highlights 2015

EUR million except where stated	2014	2015	Change
Revenue	2,285	2,324	1.7%
Operational result before exceptional items	(37)	24	-164.9%
EBIT margin %	(1.6)	1.0	+2.6ppts
Net profit	(83)	90	-208.7%
Liquid funds	426	708	66.2%
Gross debt	428	346	-19.0%
Net debt/(cash)	2	(362)	nm
Equity	514	728	41.5%
ASK (millions)	30,889	31,836	3.1%
RPK (millions)	24,772	25,592	3.3%
Load factor %	80.2	80.4	+0.2ppts

RASK (EUR)	6.70	6.65	-0.8%
CASK (EUR)	6.84	6.60	-3.6%
CASK ex-fuel (EUR)	4.71	4.73	0.4%

Finnair's 2015 margin lags global airline industry

Finnair's 2015 net profit was its best result since 2007, although it was boosted by non-recurring items, including book gains on the sale and leaseback of A350, ATR and Embraer aircraft.

The operational result was its best since 2012 and 2015's increase in revenue was the first since 2012. Last year, CAPA suggested that net losses were a hard habit for Finnair to kick, and with five losses in the past eight years it cannot afford to relax.

However, revenue remained below its 2012 level of EUR2,449 million and the operational margin of only 1.0% was below the 2012 margin of 1.8%, as well as below the 2007 pre-crisis peak margin of 4.4%. Although Finnair's 2007 margin was slightly above the global airline industry average of 3.9% that year, its 2015 margin compares poorly with CAPA's forecast global 2015 margin of 7.2%.

Finnair revenues, net profit and operating profit (EUR million) 2003 to 2015

Finnair achieves a net cash position, thanks to good balance sheet management

If Finnair's income statement has taken small positive steps, its balance sheet has taken even bigger strides. At the end of 2015 its gross liquid funds stood at EUR708 million, up by two thirds from EUR426 million a year earlier. This 2015 year end balance was equivalent to 111 days of revenue, compared with 68 days at the end of 2014.

Moreover, gross debt fell by 19% to EUR346 million at the end of 2015 and Finnair closed the year with a net cash balance of EUR362 million, compared with net debt of EUR2 million a year earlier. The ratio of net debt to equity fell from almost zero to -50%, but adjusting for off-balance sheet operating leases by capitalising them at eight times annual rentals this ratio fell from 123% to 59%.

In spite of higher capital expenditure in the year, Finnair's balance sheet benefited in 2015 from its return to profit and a consequent improvement in operating cash flow, and also from sale and leaseback transactions and the issue of a hybrid bond.

Finnair development of net debt* and cash, EUR million 2009-2015

Airline Business segment drives the result

The improvement in the 2015 operational result was driven by the performance of the Airline Business segment, which swung from a loss of EUR44 million in 2014 to a profit of EUR17 million in 2015. The operational profit of the Travel Services segment remained stable at EUR7 million.

Finnair operational result by business segment (EUR million) 2013 to 2015

ASKs return to growth

For the first time Finnair carried more than 10 million passengers in 2015. It increased its capacity in ASK by 3.1% in 2015, after a 0.9% cut in 2014, and RPKs grew at the slightly faster rate of 3.3%. Passenger load factor gained another 0.2ppts to reach another new high level of 80.4%.

Finnair's annual load factor has improved by 7.1 ppts since 2011. This reflects cautious capacity management and commercial initiatives, although the rate of improvement has slowed in the past couple of years and load factor looks to be levelling off.

Finnair development of capacity (ASK, million) and load factor (%) 2005-2015

Finnair's load factor gain was greatest in the domestic market, where it was up 1.6ppts to 68.0% in 2015 in spite of ASK growth of 10.6% (but this was the lowest load factor of any market region). It also recorded a load factor increase on its Asia network, up 0.9ppts to 82.8%, probably helped by a 2.0% ASK cut.

Its highest load factor was on its other long haul route area, the North Atlantic, where it was 83.1%, although this was down by 2.0ppts after a strong 26.2% increase in ASKs. The strong ASK growth to North America in 2015 reflected its May-2015 launch of a seasonal route to Chicago and its Oct-2015 launch of a Miami service.

Finnair ASK and passenger load factor by region 2015

	ASK million	Change vs 2014 %	PLF %	change vs 2014 ppts
Asia	15257	-2.0%	82.8	0.9
Europe	12890	5.3%	78.5	-0.4
North Atlantic	2243	26.2%	83.1	-2.0
Finland	1446	10.6%	68.0	1.6
Total	31836	2.2%	80.4	0.2

The 2.0% cut in ASKs to/from Asia was Finnair's second successive annual reduction in capacity to the region, taking its share of the airline's total ASKs down to 48% in 2015 from 51% in 2013. Over the longer term, Asia remains Finnair's key strategic growth market and it plans to double its traffic to the region from 2010 to 2020. In May-2016, it will launch services to Guangzhou and Fukuoka (the latter making it the only airline with nonstop flights from Europe to four major Japanese cities).

See related reports:

Finnair's A350 delivery brings more growth to Helsinki-Vantaa Airport. Now to attract other airlines

SAS Scandinavian Airlines vs Finnair: the original Europe-Asia Nordic leader tries to fight back

The introduction of the first A350-900 into the long haul fleet, used on the Shanghai route from 21-Nov-2015, was the catalyst for a slight ASK increase to Asia in 4Q2014. The ASK increase was the result of the A350's higher number of seats compared with Finnair's existing long haul fleet of A330 and A340 aircraft. Finnair is now deploying A350s on Bangkok and Beijing, and the next A350 route will be Hong Kong in late Mar-2016.

Finnair 4Q2015 ASK, RPK and passenger load factor by region

Revenue up 1.7%

Finnair's total revenue growth of 1.7% (compared with a fall of 4.8% in 2014) was slower than its ASK growth of 3.1%. The Airline Business segment accounted for 91% of revenue and achieved revenue growth of 2.2%.

Revenue per ASK (RASK) based on its external revenue divided by ASKs fell by 0.8% in the Airline Business segment - note that this differs from Finnair's reported RASK, which is based on adjustments for cargo and on-board sales, which cannot be replicated from its publicly reported data.

The Travel Services segment's revenue fell by 3.2%, although this division managed to maintain its 2015 operational result at its 2014 level.

Finnair external revenues (EUR million) 2014 and 2015

Segment	2014	2015	Change	% of 2015 revenues
Airline Business	2070.7	2117.1	2.2%	91.1%
Travel Services	213.8	206.9	-3.2%	8.9%
Total	2284.5	2324.0	*1.7%*	*101.7%*

Costs down 1.0%, thanks to lower fuel prices

Finnair's operational costs fell by 1.0% in 2015, in spite of capacity and revenue growth. The fall in costs was due to a 9.8% reduction in fuel costs; this was the result of lower fuel prices, partly offset by a weaker EUR versus USD and Finnair's hedging programme, which partly delayed the benefit of lower market prices.

According to CAPA calculations, Finnair saved EUR85 million in 2015 compared with the cost it would have faced if it had paid the same average fuel cost per ASK as in 2014. This figure dwarfs the EUR24 million operational profit.

Non fuel costs were up by 2.5%, the same rate of growth as for labour costs. Costs such as traffic charges (+12.0%) and operating leases (+26.0%) were inflated by the strength of USD.

Finnair operational costs 2014 and 2015, EUR million

	2014	2015	Change	% of 2015 costs
Staff costs	344.5	353.2	2.5%	15.2%
Fuel	660.4	595.5	-9.8%	25.7%
Aircraft leases	78.8	99.3	26.0%	4.3%
Other rental	159.7	159.4	-0.2%	6.9%
Fleet materials and overhaul	119.4	118.9	-0.4%	5.1%
Traffic charges	230.9	258.5	12.0%	11.2%
Ground handling & catering	251.8	250.3	-0.6%	10.8%
Tour operations	76.7	79.6	3.8%	3.4%
Sales & Marketing	65.3	74	13.3%	3.2%
Depreciation	134.3	108.1	-19.5%	4.7%
Other	217.4	219.3	0.9%	9.5%
Total	2339.2	2316.1	*-1.0%*	*100.0%*
Costs ex fuel	1678.8	1720.6	2.5%	74.3%

Fleet transformation led by A350

2015 was a milestone year in Finnair's fleet development. It took delivery of its first A350 (and Europe's) in Oct-2015, and had three in the fleet by year end. In total, it has ordered 19 and there will be five within 1H2016, seven by the end of 2016, 11 by the end of 2017 and 19 by the end of 2023.

It will phase out its A340 fleet by the end of 2017, including the sale of four aircraft back to Airbus as part of its A350 delivery agreement, thereby ensuring a smooth transition. Finnair's A350s have 297 seats, compared with 269 or 270 seats in its A340s and 263, 271 or 297 in its A330s.

There have been some minor delays in A350 deliveries by Airbus, but on a conference call to discuss the 2015 results CEO Pekka Vauramo reassured analysts that Finnair was planning to ensure that any customer disruption was minimal. Furthermore, Airbus was providing compensation where any additional cost was incurred.

Finnair's all Airbus narrowbody fleet will be re-equipped with higher density seating, adding between six and 13 seats per aircraft from 2017. As a result, its short/medium haul aircraft will add 4% to the ASKs flown.

Overall, the fleet changes should lead to lower unit operating costs, as a result of more efficient engines and a larger number of seats per aircraft.

Finnair Fleet Summary as at 11-Feb-2016

Aircraft	In Service	On Order*
Airbus A319-100	9	0
Airbus A320-200	10	0
Airbus A321-200	11	6
Airbus A330-300E	8	0
Airbus A340-300	1	0
Airbus A340-300E	4	0
Airbus A350-900XWB	3	16
Total:	46	22

Unit labour cost grew in 2015, but the longer-term trend of productivity is positive

The 2.5% increase in labour costs noted above came in spite of a 5.1% fall in average headcount in 2015, meaning that there was an 8.1% increase in employee costs per employee. This was mainly due to a provision for a new share-based incentive scheme for pilots, as well as addressing other staff bonuses, additional cabin crew holiday pay and early retirement provisions.

This more than offset the positive effect of improved labour productivity (ATK per employee was up 5.1%), pushing employee costs per ATK up by 2.8% in 2015. Moreover, the increase in revenue per employee, up 7.1%, did not match the growth in employee costs per employee.

However, 2015's increase in employee costs per ATK should be seen in the context of a longer-term downward trend. Indeed, there have been strong improvements in labour productivity since 2011, on a number of measures.

From 2011 to 2015, Finnair cut its average headcount by 34%, and although employee cost per employee increased by 18%, the remaining employees each generated 54% more ATKs. As a result, employee costs per ATK fell by 24% from 2011 to 2015. Over the same period, revenue per employee jumped by 57%.

Finnair labour productivity measures 2011, 2014 and 2015

	2011	2014	2015	Change 2015 vs 2014	Change 2015 vs 2011
Average full time equivalent headcount	7,467	5,172	4,906	-5.1%	-34.3%
Total labour cost EUR million	455	345	353	2.5%	-22.4%
Employee cost per employee (EUR)	60,988	66,609	71,993	8.1%	18.0%
ATK per employee	612	898	944	5.2%	54.3%
Employee costs per ATK (EUR cent)	9.96	7.42	7.62	2.8%	-23.5%
Revenue per employee	302,397	441,705	473,706	7.2%	56.7%

RASK outperformed against CASK in 2015

Since labour - 15% of total costs in 2015 - is the second largest cost category after fuel - 26% of costs - labour productivity is vital to the efficiency of Finnair's unit cost (cost per ASK, CASK). Its improved operational margin in 2015 was the result of a bigger fall in CASK (-3.6%) than RASK (-0.8%).

Although this unit cost cut owed much to lower fuel prices, Finnair's focus on labour productivity and its investment in labour incentive schemes should reap rewards in the future.

Finnair* - index of operating cost per ASK and revenues per ASK (each indexed to 100 in 2009)

Finnair's outlook is brighter than for some years

In 2016, Finnair expects growth in both capacity and revenue, in spite of what it calls "renewed uncertainty" in its markets - a reference to both the macroeconomic and geopolitical outlooks.

It has not announced a capacity growth target, but indications from OAG schedules data into summer 2016 suggest seat growth in the low single digits in Europe, a return to growth in Asia Pacific of close to 10% (Guangzhou and Fukuoka launches; use of A350 on Shanghai, Bangkok, Beijing, Hong Kong) and 15% growth on North American routes (increased capacity to Chicago; Miami service extended to full year). This would mean total growth above the 3.1% ASK increase of 2015.

Finnair will only set a profit target after its 1H2016 results, but it has said that "the lower price of jet fuel supports [its] financial performance in 2016". This can be interpreted as another increase in operational profit, helped by lower average fuel prices net of hedging.

The key unknown will be the extent to which lower fuel costs are passed through to passengers in the form of lower fares. Unit revenue was again weak in 2015, particularly after removing the positive impact of currency movements, and it is difficult to see it solidifying much in 2016.

Nevertheless, labour agreements reached in 2014 and the fleet improvements that are now under way may well combine with low fuel prices to give Finnair its brightest outlook for some years.