Air France-KLM chief raises stakes in dispute with pilots

The chief executive of Air France-KLM is threatening to halt the development of the Franco-Dutch airline group's budget carrier in France and expand elsewhere in Europe if no agreement is reached with the French pilots union ahead of a strike planned for next week.

Alexandre de Juniac told the Financial Times the group will "stop all new projects" at Transavia France - a low-cost carrier unit where employees are paid less than at Air France's mainline business - if the pilots do not back down.

His tough message underlines the struggle by Europe's largest flag carrier groups to reduce their costs and compete effectively against budget airlines led by Ryanair and easyJet, which have established leading positions on short-haul routes over the past two decades. Air France-KLM, International Airlines Group and Lufthansa are pursuing different solutions to this challenge, but all are engaged in a slow and grinding exercise to improve efficiency.

The French pilots union wants its members at Transavia France - established in 2007 - to have the same working conditions as those at Air France's mainline business. They have threatened a week-long strike that analysts say could cost the lossmaking group as much as €40m a day.

"We say no, there is Transavia and Air France, but they are two separate worlds," says Mr de Juniac in a late-night interview at Paris' Charles de Gaulle airport. The 51-year-old executive yawns after a long day spent negotiating with unions.

The interview came as Mr de Juniac was finalising the group's new five-year strategy, announced on Thursday, which focuses on more than doubling the Transavia fleet across Europe.

The group will invest €1bn in Transavia, growing the fleet from 47 aircraft currently to 100 in 2017 and 115 by 2019. Expansion will include three new bases outside France and the Netherlands, with two likely in Portugal and one in Germany, as Transavia focuses on flying holidaymakers to their destinations.

Mr de Juniac wants to increase Transavia France's fleet from 14 to 35 aircraft, but that is conditional on an agreement with the unions.

"If we cannot find an agreement on Transavia France, we will stay as we are with 14 planes, we will stop all new projects with Transavia France, and we will develop Transavia Europe," he says.

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Michael O'Leary, Ryanair's chief executive, says the efforts by flag carriers to compete on cost are "doomed to failure" because of legacy issues - such as collective bargaining agreements with unions and large pension liabilities.

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Ryanair operates at about 3.3 euro cents per available seat kilometre - a measure of unit cost, or efficiency - compared to 4.9c at Transavia and 7c at Air France-KLM's mainline businesses, according to analysts at Oddo Securities.

Jamie Baker, analyst at JPMorgan, says flag carriers face significant difficulties when establishing a budget airline within the broader group, adding it involves a cultural shift towards a low-cost mindset. This is "not unlike trying to convert the religiously devout", he says.

Partly for this reason, Mr Baker praises the move last year by IAG, parent of British Airways and Iberia, to take over Vueling, a Barcelona-based low-cost airline.

He says it is better for legacy carriers to buy an existing budget airline than to create their own. "It's better to adopt than to procreate," he argues.

The problems for flag carriers were highlighted on Wednesday at Lufthansa, where pilots went on strike for the third time in two weeks over company proposals to raise the early retirement age.

The strikes have caused huge disruption, prompting the cancellation of hundreds of flights, and people close to the German airline group suspect the root cause of the industrial action is new chief executive Carsten Spohr's plan to launch more low-cost, short-haul services in Europe, and a no-frills long-haul airline.

One reason for Mr Spohr's interest in establishing a long-haul, budget airline is competition coming from Gulf carriers. Emirates Airline, the fast-growing Dubai-based airline, enjoys certain cost advantages, such as low landing charges at its home airport.

"I have to make a trade-off between our long-term perspectives and short-term burdens," said Mr Spohr on Wednesday. "If conflict is needed for change, I regret that, but the reasons that force us to change won't go away."

Air France-KLM, also grappling with competition from the Gulf carriers, turned an operating profit for the first time in three years in 2013 as restructuring measures started to bite, but still lost €1.8bn at the bottom line.

Mr de Juniac is hoping Transavia can contribute to Air France-KLM's earnings recovery, and is convinced that despite issues with the unions, the low-cost unit can succeed in its battle with the budget airlines.

He adds the group would be "offensive as well as defensive" in fighting back against rivals, doing "everything we can to stop, and to reconquer, to regain market share as fast as possible from the low-cost players".

But Yan Derocles, analyst at Oddo Securities, injects a dose of caution. "The best that Lufthansa and Air France-KLM can hope for are defensive moves against the low cost players. The unions and other legacy issues make it very hard to really compete."

Air France-KLM unveils new strategic plan

In its new strategic plan unveiled on Thursday, Air France-KLM set itself a target of increasing core earnings by 8 to 10 per cent a year through to 2017.

The lossmaking Franco-Dutch airline group published Perform 2020, which has a heavy focus on restoring profits at its short and medium haul operations, and its cargo business.

Air France-KLM's cargo business, like those of rivals, has suffered since the financial crisis, when transportation of goods by air declined. There have too many aircraft chasing too little business, and Air France-KLM is responding by cutting its freighter fleet from 14 aircraft to five.

Meanwhile, the group is seeking to expand its profitable maintenance business, which services Air France-KLM's aircraft and those of other airlines, and will consider acquisitions.

Air France-KLM stressed that the centrepiece of the group, its long-haul operations, would not engage in large-scale expansion - such a move could put pressure on ticket prices and therefore revenues.

Aircraft capacity is expected to increase at a rate of between 1 and 1.5 per cent each year between 2015 and 2017.

The new strategic plan follows on from Air France-KLM's Transform 2015 restructuring programme, which involved cutting thousands of jobs and a return to operating profit last year. The group reported a net loss of €614m in the first half of 2014, but recorded operating profit of €238m in the second quarter - almost triple the amount of one year ago.

Air France-KLM is seeking to keep once problematic leverage under control. In 2017, adjusted net debt should be less than 2.5 times earnings before interest, tax, depreciation, amortisation and rental charges, or ebitdar. At June 30, the ratio was 2.6 times.

Shares in the group were up almost 2 per cent on Thursday and have risen by 14 per cent since January.

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