Analysis of Alitalia’s balance sheet and income statement relating as at December 31, 2015 for www.AVIONEWS.com

October 30, 2016 0 By Gaetano Intrieri

Firstly I would like to thank such a historic and prestigious press agency as Avionews for thinking of me for this analysis work.

The goal of this work is to define the financial condition of our national airline through the reclassification and analysis of some items that I considered to be the most critical with respect to the income result and deliberately ignoring those that while also influencing the end result have less impact than those which have bee suggested elsewhere.

The cost items recognized as equity

The notes to the 2015 balance sheet state the following:

Tangible assets, consisting of the owned fleet, the maintenance activities, the fleet under finance leases, the improvements on aircraft of third parties and other tangible assets and assets in progress have balanced at December 31, 2015 560,351(€/000) showing an increase of 247.074(€/000) in the year, as shown in the following table:

TANGIBLE ASSETS €/000

12/31/2015

01/01/2015

change in the value

Fleet

444,774

258,844

185,93

other tangible assets

115,577

53,803

61,774

TOTAL

560,351

312,647

247,704

Alitalia then states us that it has recognized more than 560 million € of expenses as assets. What does it mean? It means that these outputs have no place in the Income Statement, in other words they do not contribute to the result from operations of the year 2015. At this point the reader might begin to suspect that Alitalia’s losses are much higher than those declared in the Income Statement and those suspicions may also have their merits, so let’s go focus on the items that make up the amount charged as equity, not before making clear however  that the charges listed by Alitalia are entirely lawful and consistent with IFRS standards, so the approach is absolutely legitimate and feasible.

Alitalia reported in in the note of its financial statements  that that the Fleet item includes:

1) the owned aircraft and improvements on these air

2) the back-up engines

3) the improvements in aircraft leased by third parties

4) the improvements in aircraft in financial leasing

There is given a value of 173,493 (€/000) to owned aircraft on which there is much to say, but due to an excess of goodwill we define a real book-value to be, therefore consistent with market values, just because we add on something that leaves us even more perplexed, the increment values on which we learn how to capitalize on more of everything:

  1. 35.677 (€/000) for rotable purchases, so that account in equity the spare parts when it is obvious they are a direct operating cost;
  2. 14,647 (€/000) for the cyclical reviews that are maintenance operations planned for the airframe of each aircraft in compliance with the Maintenance Program of the manufacturer, for as approved by the CAA of competence;
  3. 3,173 (€/000) for engine and APU overhauls;
  4. 9,529 (€/000) for the improvements in aircrafts owned;
  5. 5,445 (€/000) for the purchase of a backup engine for an ERJ 175 (paid a lot of money, even if it was overhaul).

Indeed, in 2015, with regard to the fleet of aircraft owned, Alitalia allocates to assets a total amount of approximately € 70 million, of which considering eligible the value of the improvements and the acquisition value of ERJ175’s engine, we have about 16 million for investments, while the remaining 54 million are pure cost that is reasonable to capitalize, only to create a cost rate, but must be at least 65% expensed in the current year in a directional budget context. In other words, only in relation to owned aircraft, alone there are about 35 million of costs that are capitalized and it is no coincidence that the financial statement  editors are forced to account for more than 23 million of depreciation in the period considered; a huge figure that will condition a lot future years.

But let’s go ahead and concern ourselves aircraft from third parties that AZ had in its fleet. In this regard the notes informs us that have been capitalized:

a) 23,288 (€/000) for airframe revisions, provided by the maintenance program

b) 31,705 (€ / 000) for engines revisions

c) 1,444 (€/000) for APU revisions, landing gears and thrust reserve

d) 12,239 (€/000) for improvements in aircraft and engines of third-parties

Even here we find a significant capitalization of costs of nearly € 70 million and which appears exaggerated by the fact that aircraft are not owned. Also in this case the improvements are to be considered costs and it is only the multi-annual amortization that allows Alitalia not to expense them in full in the current year.It would, acting appropriately and prudently be wise to consider at least 35 million euros in cost, instead Alitalia has chosen the policy of the ostrich, postponing the problem through an allocation to the provision for depreciation of over 37 million euros which added to the already substantial depreciation in the course will have a very negative impact in future periods on income statement, and certainly will force its shareholders to a recapitalization that at this point is inevitable, although we have not got data in relation to the exercise for 2016.

Also regard the aircrafts in financial leasing, everything is being done to reduce huge losses for the year, in fact, almost magically the value of the 5 aircraft in the leasing fleet grows in one year to 151 million € which then, net of amortization, become about 139 million €. All this is justified by a not very clear renegotiation of lease agreements. Again AZ will pay for this in the following years by way of increasing dramatically the charges relating to the amortization and making the next annual financial statements impossible to sustain.

Defining a critical component of assets recorded in the financial statements and omitting many other considerations about how it was achieved the features of balance sheet assets, we focus on the income statement in order to analyze the real causes of this unstoppable hemorrhage of money.

The main items of the Income Statement

Following we can find the income statement breakdowns extracted form Alitalia’s financial statement.

5.1 Revenues from traffic amounted to 2,821,293 (€ / 000) are articulated as follows:

Revenue form traffic

31/12/2015

€/000
Passengers

2,539,928

Passengers (others revenues)

125,391

freight transport

96,522

Post

3,244

Revenue for activities with other airlines

8,879

other revenues from traffic

47,329

T O T A L

2,821,293

5.2 other operational revenue amounted to 332,952 (€/000) are represented as follow:

others operational Revenues

31/12/2015

€/000
ancillaries form traffic

34,413

Rent and leases

49,113

airport assistance

33,076

Line Maintenance

18,977

Fleet maintenance

8,783

revenues from ADV

19,888

other revenues

168,702

T O T A L

332,952

Revenues essentially show a clear and steady decline in sales, partly softened by a different nature revenues of over 300 million, largely due to public subsidies for routes operated under the territorial continuity which account for about 170 million euros and to the aircraft rental for about 50 million euros. This last item is in fact an an internal operation because increase to the subsidiary Cityliner it involves aircraft leased indeed it is not income from third parties.

As regards the costs of the operations (dwelling on those already stated at the beginning, we have:

5.3  Raw materials and consumables amounted to € 811,969 and consist of:

SERVICE COSTS

31/12/2015

€/000
Fuel

(668,920)

Financial charges for hedging Fuel

(52,370)

technical materials

(59,915)

other materials

(30,764)

T O T A L

(811,969)

5.4 Service costs amounted to 2,020,085 (€/000) are represented as follow:

SERVICE COSTS

31/12/2015

€/000
Expenses for sale

(216,251)

Expenses for traffic and airports

(720,613)

Maintenance e revision aircrafts

(196,766)

Expenses for activities with other airlines

(17,550)

other costs

(253,813)

Rent & Lease

(615,062)

T O T A L

(2,020,085)

5.5 Staff costs amounted to 592,897 (€/000); the average number of employees at December 31, 2015 was 9,175. In detail:

STAFF COSTS

31/12/2015

€/000
Wages and payrolls

(474,481)

social charges

(79,747)

severance indemnities

(22,054)

Retirement benefits & other costs

(18,615)

T O T A L

(592,897)

The emphasis of the costs once again proves to be the true chronic problem that has always characterized the management of our national airline and, in this regard, let us clear the field immediately by a false theory that has characterized the message of many CEOs including the ‘ last came from afar: EMPLOYEES ARE NOT THE PROBLEM oF ALITALIA. Attributing the deficit to personnel costs as the primary cause of the on-going situation is the most false and hypocritical views we can support. Further reducing staff or salaries, in my view, not only does not solve anything, but it will accentuate the decline of the company for two main sets of reasons:

  1. it increases internal social conflicts
  2. it continues the drain of know-how that has characterized the last decade, with significant consequences on the quality and efficiency of internal processes.

A detailed analysis of personnel costs, shows the following:

1) an average cost per employee, net of social security charges and accessories amounted to EUR 48,000 per year, which places Alitalia in line with those of other European airlines (including Low Coast);

2) the gross cost of personnel affects approximately 18% of revenues, slightly higher than the European average, due to a policy that fails to increase sales;

3) the gross cost of personnel accounts for 16.5% of total costs, this shows that the cost of the staff is not the problem of Alitalia, it is impossible to think that this percentage of the total cost is likely to affect so negatively on earnings results .

Certainly these are not the costs that led Alitalia to another debacle of its troubled history, then, we go on to analyze what are the costs that really affect the core business:

Let’s focus on operating costs that are the real “problem” of the company:

  1. The costs of maintenance: here the figure is really exorbitant and not justified by the maintenance of any level of safety , whereas the maintenance programs of aircraft albeit with the customization allowed, must be respected by all carriers equally worth the suspension of the Air Operator’s Certificate by the Aeronautical Authority. Here is a summary of the directional reclassification of costs for maintenance during the year 2015:
    in the income statement it is reported about 250 million for maintenance costs, reviewing the fleet and technical materials to which you need to add other 150 million that are reported as current items and not expensed at cost as described above. We have so that Alitalia to maintain its fleet of aircraft spends about 400 million € which considering the 123 aircraft in operation, it means that the average spending per aircraft exceeds 3,200 € / 000. Now considering the composition of the fleet composed of 80% of medium-range and regional aircraft, the figure is at least 40% higher than the average of the current international scenario. In other words Alitalia burns about 150 million in annual maintenance, which could easily be spared.
  2. The cost of handling and passenger services for a total of nearly 300 million €, accounting for about 10% of revenues. Considering the threshold size of the company are absolutely out of range value, and in a careful and income management can not exceed 5% of revenues, indeed we are talking about 100 million deficit only related to costs for ground operations.
  3. Costs for sales totaling € 216 million and show a lack of effectiveness, considering the results of revenue achieved and also highlight 104 million spent on the reservations and sales service, equal to 4% of the ticket sales and twice the fee media recognized to CRSs for this kind of services.
  4. As regard the fuel costs, Alitalia fails to take advantage of the substantial decrease in the oil price that has characterized the year 2015, in fact, the cost per flight hour, amounting to approximately € 3.200, benchmarked to the hours of use of different aircraft and their average consumption per flight hour, shows a ratio of 6.3% higher than the average of European airlines. This is probably generated by a differential on Platts certainly be reviewed, also the cost is to be exacerbated by the operation of hedging, which generated a loss of over 50 ml Euro. Also in this case there is an over about 45 ml of € which become 100 ml with fifty lost on structured finance.
  5. The costs for rentals, hires and leasing, show other cost values absolutely not justified by the size threshold of the company and the level of intensity of operations. Alitalia actually spends more than 600 million euros for the use of third party assets, a figure very significantly high. Proper business management, under any circumstances, can accept a figure that accounts for about 20% of sales and 18% of costs. This, combined with the cost concerning the overheads, that add up to about 250 million euros (in which we find 50 million for training costs), shows even more, the level of waste and inefficiency that characterizes the management of the company.

Final Considerations

Alitalia closes the fiscal year analysed, with a loss on ordinary activities of over 600 million net of capitalized costs. Given the size threshold of the company and the undeniable advantages that Alitalia already enjoys just to have been permitted to lay off more than 2,000 people in charge to the community, this result indicates a management that can be defined as a tragic chronic situation, where it seems that employees are the trigger of all, while in fact the analysis of the numbers shows that the situation is quite different as for the financial statement.

Alitalia is characterized by a short-sighted strategic vision not having been able to find a satisfactory market position. In addition, the operational and indirect costs management is totally out of control, especially considering the new management control models, increasingly implemented in aviation by profit companies, some of which use complex systems with neural algorithms based on Boolean logic.

The costs are excessive because they are originated from a structural dysfunction linked to enterprise size threshold, in other words Alitalia is too small to be big and too big to be small, it lives in a strange environment where create a winning strategy becomes almost mission impossible. The maintenance contracts should be reviewed, just as an example, some time ago I hd the occasion to see the Repair & Specification manual of Alitalia’s engines and some components of management policy it is in my opinion extremely onerous and easily it could save at least $ 200,000 for each engine overhaul. As regards airframe maintenance, Alitalia uses a customized maintenance program which I think it is very redundant and therefore increases costs.

Also, I do not think there are internal mechanisms of economic control of flight operations or models that use inferential statistics to predict with a good chance of approximation the exogenous variables in the internal model which characterize this business model. Moreover, considering that in the Italian market, the main competitor in the short-medium range has implemented sophisticated performance monitoring models to determine the level of efficiency according to the method described above and it has an average cost per flight hour of 35% less than Alitalia with the same capacity of the aircraft,  we can deduce that once again the situation seems to be particularly sad with Alitalia.

Finally I think we can say that considering the significant impact that the depreciation will have on the income statement of the current year, I believe that the recapitalization of the share capital will be a necessary act, and we must hope that shareholders will want to meet this deadline, otherwise, once again, after the many billion euros that Alitalia has cost to the community, we will have to pay once more for the the private loss with our public money.