AER Lingus is heading for serious financial difficulty unless major cost saving are agreed, according to a confidential report. NCB Corporate Finance warns company management and its unions that "determined action" is needed to pre-empt a repeat of the 1993 financial crisis. It concludes that "if these warnings are ignored Aer Lingus will be unable to remain viable."

The primary problem is that the airline needs a high level of profitability to pay for investment in fleet replacement in other areas, but is faced with low profit margins and high costs.

Already chief executive Mr Gary McGann warned in April, when the group's 1996 results were published, that the fall in operating margins in its core business was "a significant warning signal that has to be addressed." The company, he said, needed to address its cost base.

The NCB report puts flesh on the bones of his warning. Pay costs remain a crucial factor and NCB gives a blunt assessment on the dangers of rapid wage growth to the company's finances.

This is the background to the recommendation from independent arbitrator Phil Flynn for a special 5.5 per cent increase for employees this year, in return for agreement on discussions on a major cost saving package. He earlier recommended changes to a Tribunal recommendation of a 17 per cent rise for the airlines pilots. The company and unions are considering his plan.

The NCB report, undertaken far Mr Flynn, contains details of a previously unpublished "Strategy for Profitable Growth 1997-2001" plan agreed by the Aer Lingus board last year. Under this plan, group operating profits were forecast to be £36.6 million this year (a forecast drawn up before 1996 figures for £41.8 million would have been known). Operating profits were to rise to £48.3 million by 1999 and remain at roughly this level for the subsequent two years.

However NCB believes this plan to be too optimistic. It says it needs to be adjusted to take account of a possible market downturn in the core air transport business, the loss of cargo contracts and greater competition in a range of areas. NCB also seriously questions the airline's plan for cutting costs. Over £29 million in savings have planned for over the next five years, but the advisers say that from their review £12 million of these savings have not been specifically identified, and will thus be hard to achieve.

While the NCB report, completed in May, does not make adjustments for the TEAM aircraft maintenance operation, it warns that "from our review that any risk to the plan for TEAM is on the downside."

Based on its calculations, NCB says that operating profits this year are likely to be around £30.2 million, compared to the £36.5 million predicted in the plan approved by the board. However the outlook is bleaker in later years, with NCB predicting profits of just £11.1 million by 1999 - compared to the board's £48.3 million. For 2001, the last year of the plan, a loss of £9.6 million is forecast by NCB compared to the board's profit forecast of £46.2 million. The advisers calculate that the minimum level of operating profit required is £40 million per annum to fund fleet replacement and other investment.

The report concludes that major savings are needed to ensure annual operating profits reach the £40 million threshold. Its calculated that savings would have to build to an annual total of over £80 million by 2001, but this was based on the pilots' 17 per cent award being offered to all staff, which is not now on the table.

However even under the more modest Flynn pay recommendations, major savings would be needed. He proposes that the company's management and unions discuss savings building up to £42 million a year in five years time in line with the existing corporate plant - plus extra savings which would be needed to pay for the pay awards now under discussion, which would probably cost around £8 million per annum. So the total savings sought will be on a par with the £50 million found in the Cahill plan.

Clearly Mr Flynn has sought to find a balance between giving the employees something while ensuring that the warnings in the Aer Lingus report are heeded. The next few weeks will tell whether his plan can become airborne.