What's the next step for the airline after boasting its strongest balancesheet in its history and will its management be able forthe challenge? Emmet Oliver reports

When Brian Dunne, chief financial officer at Aer Lingus, this week described the airline's 2003 results as the "strongest balance sheet in its history" one could almost sense the nervousness in the room.

Aer Lingus has had more false financial dawns than probably any airline in Europe. As soon as someone pronounces Aer Lingus to be in rude financial health, events move in the opposite direction and the initial optimism evaporates.

But maybe this time the optimism of Mr Dunne and his chief executive Willie Walsh is well founded.

The airline's balance sheet as of December 2003 is certainly healthy. Operating profits rose in 2003 from 63 million to 83 million, despite a 7.3 per cent fall in turnover.

Free cash was up to € 384 million, which is equivalent to half a year of the airline's total operating costs. Earnings per share rose in 2003 by 96.4 per cent to just over 27 cent.

While these are purely annual results, the airline's underlying performance is no less impressive.

After years of anaemic margins in the 3-4 per cent region, the airline now boasts operating margins of 9.3 per cent and hopes to push this to 15 per cent in the next few years.

A report issued by Davy Research described this as "the most aggressive target of any network airline in Europe".

Load factors (the number of seats filled on each flight) now stand at 81 per cent. Low debt levels and the signing of a new short-haul fleet deal with Airbus completes a pretty encouraging corporate profile.

Not a bad two-and-half year performance from former pilot Capt Willie Walsh. When he took over the airline, many feared it would follow Sabena and Swiss Air into bankruptcy.

The opposite has happened and the airline is now going to be floated, according to the Minister for Transport, Mr Seamus Brennan.

While Mr Walsh denies his role is to ready the airline for market, there is little doubt the airline would prove attractive to private institutions - at least right now.

There are various attractions: reasonable profitability by European standards; potential access to a huge network of US airports if the US-EU bi-lateral agreement is changed; a new short-haul fleet; attractive landing slots at Heathrow; and an internationally recognised brand.

Mr Joe Gill, head of equity research at Goodbody Stockbrokers, believes the airline is now attractively lean, but more may need to be done. He points out that Aer Lingus has one employee per 1,378 passengers, but at EasyJet it's 5,000 passengers per employee and at Ryanair it's 9,000 passengers per employee.

While Mr Walsh has used a voluntary severance package to lure more staff from the organisation, one suspects the numbers could tumble further.

However, what this might do to the industrial relations climate at Aer Lingus remains to be seen.

The airline may have no choice but to cut numbers - fares around the world are expected to fall another 10 per cent this year and the airline has simply got to bring its cost base in line with that, Mr Walsh told The Irish Times this week.

"It is an evolving situation. We don't have the luxury that existed in the past where you could put prices up and improve your position that way," he explained.

Asked was 4,000 staff still too high a figure he replied: "It is. I think the important issue is we have the right number of staff for the operation and, given that the operation changes all the time, it is not a question of saying 4,000 today is too many. You have to have the right number.

"The move to a single fleet will make us more efficient and that will throw up surplus staff in a number of different areas," he said.

One of the airline's attractions for investors - private institutions most likely - is the short- haul fleet deal done last year with Airbus. Critically, the cost savings from this really start to kick in during 2005, possibly the time when new owners will come on board.

While the purchase price was never disclosed, it is likely that Airbus was forced to discount heavily to beat rival Boeing.

According to Davy Research, the benefits of the deal cannot be under-estimated.

"It streamlines the fleet to a single type short-haul and long-haul aircraft. It delivers significant underlying cost savings, notably in maintenance and fuel."

The increased growth of internet bookings should also help the airline to cut distribution costs to the bone.

There is also the hidden value of its slots at Heathrow Airport.

The Government is set to examine whether these valuable assets should form part of the sale of the airline. The landing slots are believed to be worth up to €120 million.

Last October, British Airways paid £12 million (€17 million) for four slots from US carrier United Airlines.

Aer Lingus has 20-30 slots, depending on the time of the year. Aer Lingus management is believed to oppose any plan which withholds the slots from any sale process because the airline's value would be seriously eroded.

The challenge for the airline is where does it go from here? Due to the short-haul deal, the airline has effectively added 30 per cent of extra capacity to its European routes. How is it going to use this capacity and how much revenue can it produce?

Aviation analysts suggest the airline has no pressing need for fresh funds in the short term. But, in the long term, if it wants to renew its Airbus 330 long-haul fleet, capital will be needed. The list price of an A330 is about €90 million so a new six or seven plane fleet could put some strain on the Aer Lingus balance sheet. A flotation or private placement would provide the funds.

Asked about his views this week during an interview, Mr Walsh said: "There hasn't been an IPO [inital public offering\] in Ireland since December 2000 and I think it was Paddy Power. OK, so you'll probably see Eircom this year and there is speculation about others, but the critical issue is if you start a process, you have to be confident that process is going to be successful. And when it comes to an IPO, there are just risks around that. Now that could change."

The airline, in other words, still favours an institutional placement at this stage. Asked this week whether he thought there would be a flotation or private placement this year, Mr Walsh said: "I honestly don't think about it."

Some observers have questioned whether the young management team at Aer Lingus - Mr Walsh, Mr Dunne and chief operations officer Mr Seamus Kearney - will stay on if there is no sale of any kind.

Mr Walsh has already taken a board seat at Fyffes, but the former pilot said there was no issue of him departing Aer Lingus. "I have worked for Aer Lingus for 25 years now and when I took this job two-and-a-half years ago, I said I was committed to making Aer Lingus a successful company and I remain committed to Aer Lingus today."

The youthful management team is one of the attractions of Aer Lingus as an investment, suggest analysts.

The challenge ahead for this management team is to take Aer Lingus to the next level. Mr Gill points out that the airline, by charging low fares on trans-Atlantic routes, is trying to bring the low-cost model to that market for the first time.

Another avenue for expansion would be a European hub that would allow Aer Lingus to fly within Europe.

Mr Gill says that, while this might make logistical sense, it would be highly risky.

Davy also plays this down. "Aer Lingus has a well-known brand in the UK and US, but not in continental Europe."