We encountered the realisation of two implausible thoughts last year — the British vote to leave the EU and the US election of President Trump. Last month we met another: the outstanding success of the election of Emmanuel Macron as Président of the République Française (with 66% of the popular vote — the highest since Charles De Gaulle in 1959) and the subsequent overwhelming majority of his newly-founded centrist party La République en Marche! in the National Assembly, to the virtual annihilation of the established political parties. The new president promises a “new broom” to revitalise the French economy. This could have a dramatic impact on the French corporate sector — even on Air France-KLM.
France, despite being the world’s sixth largest economy lags in the competitive stakes. According to the World Economic Forum’s Global Competitive Index the country comes in a poor 21st place in the world rankings — compared with for example the Netherlands (at no 4), Germany (no 5) and the UK (no 6). Among the elements of core pillars of the survey’s criteria it gets marked down especially by lack of labour market efficiency (placed at no 51 in the world, behind Germany at no 22, Netherlands at 14 and the UK at no 5).
Historically France has had rigorous and inflexible labour and employment laws. These generally favour the employee (which is not always that bad an idea) but have created an inflexibility perhaps incompatible with 21st century reality as we go through the fourth industrial revolution.
Within Europe the country has one of the highest employer costs — second only to Belgium: according to the annual tax-burden analysis of typical EU workers from the Belgian-based Institut Économique Molinari, in 2015 a French company would have had to pay a total of €2.20 to provide an employee with €1 of take home pay (see chart). This is not the whole story — and excludes the impact of VAT rates, widely varying average incomes and benefits.
In 2016 the French Government under the Hollande presidency tried to introduce a modest increase in flexibility for employers: a relaxation of the 35-hour week to make it an average rather than an absolute limit (and a trigger for overtime payments); greater freedom to reduce pay; easing of conditions on dismissing workers; more leeway for employers to negotiate holidays and special leave. The proposals led to a series of violent demonstrations and significant opposition in the National Assembly. In the end the law was introduced by decree.
It looks as if Emmanuel Macron wants to go further. His main challenges appear to be to tackle the 10% unemployment rate (nearly 25% for the under-25s), bloated public spending (56% of GDP in France compared with 44% in Germany and 39% in the UK), and generate economic growth.
In the next five years he apparently aims to make budget savings of €60bn so that France sticks to the EU’s government deficit limit of 3% of GDP (which it has not achieved since the global financial crisis). He has stated that he wants to cut the civil service employment by 120,000 by natural wastage — or by just over 2% (5.3m people, 21% of the active population, are employed by the state). France’s retirement age will remain at 62, but sweeping reforms are planned to the generous state pension schemes, to bring them into line with private schemes. Corporation taxes could be cut from 33% to 25%.
He and his executive will no doubt encounter significant opposition from the militant French unions and the left-wing parties. But with a strong majority in the lower house — and a significant number of political ingénus as deputies with backgrounds in the real world — he just may be able to swing it in creating an economic revolution as important to the future invigoration of the French economy as had been the Thatcher reforms in the UK in the 1980s. This is not to say that it would create an Anglo-Saxon economic model, but rather give the opportunity to create the reforms to generate a more liberal economy and maybe even abandon the traditional sclerotic French dirigisme.
Meanwhile Macron has also started to try to reinvigorate the Franco-German axis of control within the EU. Germany’s Chancellor Merkel is also due to face an election in the autumn, and although seemingly favourite to win a fourth term in power, is sensitive to anti-establishment political views. In May the two agreed to pursue a “common road map” for Europe, neither discounting the possibility of treaty change. It may be unlikely that Macron will win over the Germans to his view of greater fiscal integration in the Euro-area, but his enthusiasm could lead to some form of restructuring and reform of the EU itself. The question may be whether such reform develops into greater protectionism or a significant liberal structural reform.
This would all be somewhat ironic in the light of the British decision to leave the EU, partly for lack of reform; and the UK no longer has any influence in EU decision making.
Macron however is no revolutionary, but a well-entrenched member of the political élite establishment. He is an énarque — a graduate of the École Nationale d’Administration (ENA) set up in the aftermath of the second world war to “democritise” the appointment of French civil servants on a meritocratic basis. It only produces 80-90 graduates a year (this compares with the thousands that graduate each year from the Ivy League Universities in the US or Oxbridge/Russell Universities in the UK) but many go on to control politics and business in France.
Air France — reflecting the malaise
Jean-Marc Janaillac, Chairman and CEO of Air France-KLM, like Macron, is also an énarque (interestingly a graduate of 1980 and a contemporary of French political luminaries such as François Hollande, Dominique de Villepin, and Ségolène Royal among others). So also was his predecessor Alexandre de Juniac, who decamped to run IATA; and so too his predecessor Jean-Cyril Spinetta who ran Air Inter from 1980 and Air France from 1997. (It is almost as if graduation from ENA is a required qualification for the job.)
Air France has had severe labour issues going back decades that it has found almost impossible to address. Through the group’s various restructuring programmes in the past ten years (“Transform 2015”, “Perform 2020” and now “Trust Together”) it has attempted to pursuade its unions that there is a need to improve productivity. This has failed and resulted in damaging strike actions by flight and cabin crew.
Three years ago the company took the idea of expanding Transavia France into a pan-European low cost operation. The pilots didn’t like the idea of seeing a sister company expand where pilots were paid less or worked harder. The company did open a base at Munich (albeit using Transavia’s Dutch operation) — which actually seems to have been doing quite well. But this will close in the autumn and the plan now appears to retrench to operating Transavia out of the respective local markets in the Netherlands and France.
Not but what Transavia has been expanding very strongly (see chart) and Air France has gradually been transferring slots at the heavily constrained Orly airport from mainline operations to Transavia. On the whole Transavia appears to have a competitive low cost base: it just hasn’t yet been that profitable, although it broke even at the operating level in 2016.
The latest idea is to create a lower cost network airline based at CDG, nominated the “Boost” project (although if it gets of the ground — planned for winter 2017 — it will probably have a more chic brand name). Described as an “ambitious” business plan to develop profitable growth. The company aims to run on unit costs targetted to be 15%-18% below those of Air France itself (from which it would wet-lease the equipment) and have an effective “B”-scale wage agreement for the cabin crew. It is expected to focus on ultra-competitive long haul routes (and operate short haul feed) and account for 10% of Air France’s total activity by 2020.
In contrast British Airways managed to pursuade its unions to leave the regulated era more than a decade ago and accept more flexible working conditions (even though it is having a few problems at the moment). Iberia, under IAG leadership, successfully went through a restructuring after the 2008 financial crisis significantly to improve employee productivity. It looks as if Lufthansa’s measures in the last few years in pushing through a move to develop a lower cost Eurowings operation is generating the employee efficiency it needs.
KLM itself has successfully implemented new collective labour agreements and seen productivity rise by around 5% in the last eighteen months. As CEO Pieter Elbers put it at the group’s investor day in May, “KLM has become increasingly competitive” to allow it to grow profitably. Indeed it has seen passenger numbers increase by 10% in the past two years (to 30m in 2016) and has managed to turn around its short haul services into generating profits.
Air France meanwhile has stagnated in the last decade (pursuing what is referred to as “capacity discipline”). In 2016 it (along with HOP!) carried just under 50m passengers, roughly the same as in 2006.
Air France-KLM is still highly geared. The group ended 2016 with a net asset value of €1.3bn almost exactly matched by goodwill and intangibles. Despite the first quarter loss this improved to €1.8bn at the end of March 2017. Against this it has reasonable levels of cash liquidity and has net debt of €3.3bn — but including capitalised operating leases (which will soon be a standard requirement) provides an adjusted debt position of €11bn against very little equity.
While the share price has performed strongly this year amid benign fundamentals, this gearing leaves the group extremely vulnerable to any downturn.
AIR FRANCE-KLM: BALANCE SHEET GEARING
|€m||Mar 2008||Dec 2016||Mar 2017|
|Adj Debt/adj equity||0.8x||∞||25.0x|