General Review
Demand in the sector has recovered from the external shocks of recent years. Average growth in demand for European airlines was more than nine per cent in 2004. Overcapacity has reduced the average price. The price competition prevailing in the Nordic market in particular has undermined airlines' profitability.
Eight new competitors have entered Finnair's domestic market during the last two years. Of these, four have already stopped operating in Finland. Those that remain are not operating profitably in current market conditions.
In the new competitive situation, Finnair moved from defence to attack in autumn 2003. Under its chosen strategy, Finnair achieved strong growth and improved load factors. The pricing reform initiated by Finnair in autumn 2003 sharply increased scheduled traffic demand and passenger load factors. Scheduled traffic demand grew by 26.6 per cent, which is triple the average growth for European airlines. The load factor for scheduled traffic rose 4.6 percentage units, which is the best performance among European airlines.
Growth in demand was boosted by the price reform implemented in September 2003 and strong growth in Asian traffic as well as by the operations in Scandinavia of the flynordic airline (formerly Nordic Airlink), acquired at the end of 2003. The fall in the average price was halted in the final quarter of 2004.
To improve profitability, Finnair continued its 160 million euro operational efficiency programme, which began in spring 2003. The savings achieved were consumed by a steep increase in fuel prices, the impact of which was accentuated in the final quarter. Finnair paid an extra 54.4 million euros in fuel costs compared to 2003.
In September the programme to acquire 29 Airbus A320 series aircraft was completed. In June the company made the decision to place an order for twelve 76-seat Embraer E170 aircraft to meet domestic and European scheduled passenger traffic needs.
Finnair's Leisure Traffic had a successful year in 2004. A rainy summer in Finland stimulated demand for holidays in the sun in the summer and early autumn. The natural catastrophe that took place on Boxing Day in Southeast Asia resulted in rearrangements in leisure travel. Some journeys intended for Southeast Asia were switched from areas affected by the destruction to other destinations in the Canary Islands and South America. The financial impact on the Finnair Group is not significant.
Financial Result
The Group's result after financial items was 11.2 million euros. The corresponding figure for the previous year was -21.7 million euros. Operating profit before depreciation, aircraft leasing payments and capital gains (EBITDAR) improved 25.3 per cent to 195.3 million euros (155.9 million) The EBITDAR margin was 11.5 per cent, compared with 10.0 per cent the previous year.
Turnover grew by 9.0 per cent to 1,698.4 million euros. Unit revenues for passenger traffic declined by 10.4 per cent and unit revenues for cargo traffic declined by 11.1 per cent. Unit revenues for traffic overall declined by 11.2 per cent.
Operating costs rose during the financial year by 5.5 per cent and units cost for flight operations fell by 11.9 per cent. The aim of the operational efficiency programme initiated in spring 2003 is to cut unit costs by at least 15 per cent during 2003-2005. The programme overall has proceeded according to plan and during 2003-2004 around two thirds of the 160 million euro savings were achieved.
Significant cost increases were in fuel costs, by 34.4 per cent, and in traffic charges, by 22.0 per cent. The largest items contributing to the fall in unit costs were achieved by Finnair's own measures in personnel costs (-22.3%), sales and marketing costs (-16.0%) and, due to aircraft modernisation and changes in traffic mix, fleet maintenance costs (-19.5%).
Personnel costs fell by 6.8 per cent. The decrease in personnel costs was achieved partly by the personnel reduction programme, which cut staff numbers by 1,200 in 2003-2004, and an amendment to Finnair's Pension Fund rules, which meant that the change in pension liability in 2004 was lower than anticipated. The combined effect of the rule amendment and a change in the Employees' Pension Act is a non-recurring improvement in the result of around 20 million euros. The proportion of the Group's total operating costs accounted for by personnel costs declined to 27.1 per cent, compared with 30.6 per cent in 2003.
Capital gains on sales of fixed assets totalled 12.0 million euros (22.1 million). Return on capital employed was 3.7 per cent (0.0%) and return on equity 2.0 per cent (-2.5 %). Earnings per share were 0.14 euros, compared with -0.19 euros the previous year. At the end of financial year, equity per share was 7.29 euros (7.24).
Investments, financing and risk management
Capital investments excluding advance payments for the financial year totalled 114.5 million euros (82.3 million). Investments include the purchase of two new Airbus A320 series aircraft in February and September 2004. A further two new Airbus A320 aircraft as well as one BOEING MD-11 wide-bodied aircraft were acquired on long-term operational lease agreements.
Operational cash flow, excluding capital gains, was 100.0 million, compared with 59.6 million euros a year earlier. At the end of the financial year, the Group's liquid cash reserves stood at 291.4 million euros and exceeded interest-bearing debt by 34 million euros. The gearing ratio has improved from -2.9 per cent at the beginning of the financial year to -5.5 per cent; adjusted for aircraft leasing obligations, gearing improved to 95.5 per cent (102.7%). The equity ratio is 42.7 per cent (44.4%). The figures are clearly better than the targets set by the Board of Directors.
In May 2004 the company arranged with an international bank syndicate a new five-year unsecured credit facility of 200 million euros, which at the end of the financial had not been used at all.
In June the company made the decision to acquire twelve 76-seat Embraer E170 aircraft, to be delivered between autumn 2005 and spring 2007, to meet domestic and European traffic needs. In addition, the company has options for eight other Embraer aircraft. The new aircraft will gradually replace the remaining Boeing MD-80 and ATR-72 aircraft. The aircraft acquisition programme will reduce the number of aircraft types in Finnair's fleet.
According to the financial risk management policy approved by the Board of Directors, the company's objective is to hedge more than half of scheduled traffic's aviation fuel purchases during the following six months and thereafter the following 12 months with a decreasing level of hedging.
The trend of the US dollar exchange rate has an impact on the market value of the Group's aircraft fleet. According to calculations at the closing date, book values do not require recognition of impairment losses.
The weakening of the US dollar against the euro has a positive impact on Finnair's operational result and strengthening has a negative impact, because the company has more dollar-linked costs than revenue.
Shares and Share Capital
During 2004 the highest price for the Finnair Plc share on the Helsinki Exchanges was 6.57 euros, while the lowest price was 4.46 euros and the average price 5.40 euros. The market value of the company's shares was 471.3 million euros on 31 December 2004. At the beginning of the financial year the market value was 449.1 million euros. During 2004, some 21.3 million (17.8 million) of the company's shares were traded on the Helsinki Exchanges. At the end of the period under review, the Finnish State owned 58.4 per cent of the company's shares, while 18.4 per cent were held by foreign investors or in the name of a nominee.
The Annual General Meeting on 7 April 2004 granted the Board of Directors the authority for a period of one year to acquire and transfer a maximum of 4,100,000 of the company's own shares. The authorisation applies to shares amounting to less than five per cent of the company's share capital.
Board of Directors decided on 18 June 2004 to start purchasing the company's own shares. Acquisitions began on 1 July 2004 and by 31 December 2004 a total of 422,800 shares had been purchased for 2.3 million euros. At the end of the period, therefore, 0.5 per cent of shares were held by the company.
Two series of Finnair Plc option rights are traded on the Main List of the Helsinki Exchanges. Both Series A and Series B each have 2,000,000 option rights, a total of 4,000,000 units. Trading in Finnair Plc 2000 B option rights (a total of 2,000,000 units) commenced on the Main List of the Helsinki Exchanges on 3 May 2004. During 2004 no option rights were used to subscribe for shares. On 31 December 2004 a total of 3,997,500 option rights were in circulation. These option rights can be used to subscribe for 3,997,500 shares, equivalent to 4.72 per cent of the company's shares.
If all the option certificates in circulation on 31 December 2004 were exchanged for Finnair Plc shares, the Finnish State's holding would be 55.8 per cent. On the basis of the option certificates in circulation on 31 December 2004, the company's share capital could rise by not more than 3,397,875 euros, corresponding to 3,997,500 shares.
On 31 December 2004 the company booked in full a provision for social security expenses arising from Series A and B option rights, a total of 169,000 euros.
Finnair Plc issued a 230 million Finnish mark (38.7 million euro) debenture loan in 1994. In 2004 the debenture loan was converted into shares to the value of 84,094 euros, which corresponds to 13,550 Finnair Plc shares. The Board of Directors of Finnair Plc decided to exercise its right to buy back the debenture loan and on 2 September 2004 the company paid back to debenture holders under the terms of the loan 5.6 million euros of debenture loan capital which had not been converted.
Personnel
During the financial year, the average number of staff employed by the Finnair Group amounted to 9,522 people, which was 4.6 per cent fewer than a year before. At year end the number of Finnair Group personnel was 9,430 (9,675). The decline in staff numbers is a result of measures implemented under the cost-cutting programme as well as the transfer to partners of certain functions, such as ground handling and loading services at domestic airports.
The company has collective labour agreements valid until the end of September 2007 with five labour unions. Discussions with cabin personnel and pilots are ongoing.
The Finnair Group has a profit bonus scheme that allows the employees of the parent company and certain subsidiaries to participate in a profit bonus payable on the basis of the Group's result and return on capital employed. A profit bonus is paid into a Personnel Fund, which is obliged to invest part of the bonus in Finnair Plc's shares. The preconditions for the payment of profit bonus were not fulfilled last year. However, in recognition of the employees' particularly good performance in difficult conditions, the Board of Directors has decided to make a transfer of 0.5 million euros to the Personnel Fund.
The Group also operates an incentive scheme based on a balanced scorecard, defined separately for each business unit, which covers most of the Finnair Group's employees. The total amount of bonuses in 2004 was 2.6 million euros. Provisions totalling 0.4 million euros have been made in the financial statements for bonuses due under the management share bonus scheme.
Board of Directors
The Annual General Meeting held on 7 April 2004 re-elected to the Board of Directors the following: Christoffer Taxell as Chairman and Kari Jordan (Deputy Chairman), Samuli Haapasalo, Markku Hyvärinen, Helena Terho and Kaisa Vikkula as members. Veli Sundbäck was elected as a new member. The term of office of Board of Directors lasts until the Annual General Meeting following the Board's election.
Performance of the Divisions
From the beginning of 2004, a system of four divisional reports has been adopted in external reporting. The reporting divisions are: Scheduled Passenger Traffic, Leisure Traffic, Aviation Services and Travel Services.
Scheduled Passenger Traffic
This division is responsible for sales, service concepts, flight operations and the procurement and financing of aircraft. Scheduled Passenger Traffic leases to the Leisure Traffic division the crews it requires. The division also leases cargo capacity for the use of Finnair Cargo Oy. In 2004 the units belonging to the divisions were Finnair Scheduled Passenger Traffic, the feeder airline Aero, the budget airline flynordic, Finnair Cargo Oy and Finnair Aircraft Finance Oy, which manages the Group's fleet.
In financial year 2004 the division's turnover grew 10.9 per cent to 1,265.8 million euros. The operating loss, excluding capital gains, was 26.8 million, compared with a loss of 44.3 million euros a year earlier.
A tight market situation and price competition contributed to a 14.6 per cent decline in unit revenues for scheduled passenger traffic in 2004. The fall in unit revenues was halted in the final quarter.
Demand for Finnair's scheduled traffic grew strongly in 2004. Demand grew by 26.6 per cent over the year as a whole, while capacity grew by 21.1 per cent, leading to a rise in passenger load factor by 4.6 percentage points to 65.1 per cent. The growth of demand and increase in load factor were the highest among European airlines.
Finnair's market share in traffic between Asia and Europe has grown. Finnair market share fell in domestic traffic following the entry of new competitors into the market. In European traffic, Finnair has maintained its market share.
Scheduled traffic departure punctuality was 89 per cent and again among the best in Europe. In the previous year, departure punctuality was 91 per cent. Arrival punctuality was 90 per cent, which was best in a comparison of European airlines.
The Estonian subsidiary Aero expanded its operations by leasing seven ATR 72 turbo-prop aircraft from Finnair Aircraft Finance Oy in addition to its two existing aircraft. At the same time Finnair transferred its entire turbo-prop traffic in south and central Finland and the Baltic states to be handled by Aero.
The budget airline flynordic has increased its market share in the Scandinavian market. flynordic flies from Stockholm Arlanda to four destinations in Sweden and also to Copenhagen and Oslo. In the next stage, flynordic will open new routes from Scandinavia to elsewhere in Europe. In 2004 flynordic carried 725,000 passengers.
In November 2003, the operations of Nordic East Airlink Ab, which had been acquired by Finnair, were transferred to Finnair's wholly-owned Nordic Airlink Holding Ab, which operates under the name flynordic. Following the transfer, Nordic East Airlink AB will be wound up through bankruptcy proceedings. This measure is due to discrepancies relating to the time before Finnair's ownership and has no impact on flynordic's operations.
Finnair Cargo is responsible for the transport of air freight. In its operations it utilises capacity on Finnair's scheduled passenger and leisure flights as well as Helsinki's gateway status. Additional capacity for cargo routes has also been leased from cargo operators outside the Group.
Unit revenues for cargo traffic declined by 11.1 per cent in 2004. The number of cargo kilos carried increased by 17.4 per cent to 86.2 million kilos. Growth continued to be strong in Asian traffic, where Finnair's Boeing MD-11 long-haul aircraft were utilised. Cargo capacity leased from outside the Group was increased gradually during the autumn, as new cargo routes were opened.
Leisure Traffic
This division consists of Finnair Leisure Flights as well as the Aurinkomatkat-Suntours package tour company, which is the biggest in its field in Finland with a market share of more than 35 per cent. Finnair Leisure Flights continues to be a strong market leader in leisure travel flights, even though more competition has entered the market.
In financial year 2004 the division's turnover grew 8.3 per cent to 354.6 million euros. Unit revenues for Finnair Leisure Flights declined by 2.2 per cent. The division's operating profit improved to 26.8 million euros (16.6 million euros). Growth of demand and fewer last-minute discounts contributed to Leisure Traffic's good result.
Leisure Traffic demand rose by 8.5 per cent at the same time as capacity was increased by 8 per cent. Passenger load factor improved by 0.4 percentage points to 89.1 per cent.
Aviation Services
This division comprises aircraft maintenance services, ground handling and the Group's catering operations as well as property management and services related to Finnair business.
Aviation Services' turnover was unchanged at 413.3 million euros. The cost-cutting programme and implemented adjustment measures led to an improvement in the division's operating profit, excluding capital gains, to 20.3 million euros (16.5 million euros). Aviation Services have achieved significant improvements in productivity.
The functions of the Finnair Ground Handling business unit were incorporated into an independent company, Northport Oy, on 3 May 2004. Northport Oy has a subsidiary, Finnhandling AB, which operates in Sweden. In cooperation with partners, the company provides ground handling services flexibly and cost-effectively at Stockholm's Arlanda Airport.
Travel Services
The division consists of the Group's domestic and foreign travel agency operations as well as the operations of the reservations systems supplier Amadeus Finland Oy.
The division's turnover grew 4.8 per cent to 91.6 million euros. The increase in turnover was due to growth in demand for travel and travel management services as well as the introduction of service and transaction fees. The division's operating profit was 6.5 million euros (3.5 million).
The travel agency sector has successfully adapted to a new earnings logic since Finnair and several other airlines discontinued the payment of commissions at the end of 2003. The travel agencies have developed new additional services and have organised centralised service centres.
Services and Products
The Finnair route network consists of a comprehensive domestic network as well as an international network that includes more than 40 destinations, of which ten are on long-haul routes. Finnair's success in European scheduled passenger traffic is based on the morning-evening concept favoured by business passengers.
Long-haul strategy exploits Helsinki's ideal position on flight routes between Asian and Europe. In 2004 the weekly flight frequency on the Osaka and Shanghai routes was increased from three to five. Finnair now flies daily to Japan and twice a day to China. In September 2005, a new route to Canton in China will open with three return flights per week.
Finnair has doubled its number of Asian flights during the last two years. Due to higher passenger volumes, an expanded Asian Terminal was opened at Helsinki-Vantaa Airport at the end of August 2004. To increase passenger comfort, bed seats will be installed in business class of long-haul route Boeing MD-11 wide-bodied aircraft during 2005-2006.
Finnair's European route network is supplemented substantially by partner routes to Central and Southern Europe, providing customers with efficient connections to all significant destinations in Europe. Bilateral cooperation with existing partners has been deepened.
In a new opening, Finnair began code-share cooperation with the Russian airline Aeroflot in the summer of 2004. As a result of this arrangement, capacity and connecting services on the Helsinki and Moscow route will improve. The companies will each continue to fly one return flight per day between the cities, but the agreement provides both companies with a morning and evening connection. Both Finnair and Aeroflot operate with Airbus aircraft.
Cooperation within the oneworld alliance generates both savings and revenue for Finnair. Finnair supplements the other oneworld airlines' capacity in traffic between Europe and the Far East.
Finnair's electronic services have been developed for both ticket sales and travel-related service needs. On the Internet, Finnair's website is the Finnish travel industry's most popular e-commerce site. The website's services, which received a make-over in February, cover both leisure and business travel. The new services also offer companies the opportunity to manage and report on their travelling electronically.
The electronic ticket, or e-ticket, is in use on all of Finnair's domestic routes, on several European routes and on New York flights. Early in 2004, Finnair also introduced the e-ticket on to its Bangkok, Singapore and Hong Kong routes. In Finland the e-ticket accounts for 90 per cent of all tickets sold. Around 55 per cent of all flight tickets are now sold as e-tickets.
A new service exploiting the e-ticket was first introduced for members of the Finnair Plus frequent-flyer programme. Passengers receive before their flights check-in information automatically in the form of a text message. The passengers only have to accept or reject the offered check-in. Most customers covered by the service are using it, and this is speeding up departure formalities.
Many airlines have cut their in-flight services or have started to charge for them. Based on feedback from customers, the business class catering service on Finnair flights was renewed and diversified. In contrast with competitors, a hot meal is also served in economy class on all flights of more than two hours.
The aim of the changes is to boost competitiveness. Finnair's goal is to provide Europe's best cabin service. This goal was achieved in 2004 when Finnair's business class service was ranked Europe's best in a survey of competitors. Independent evaluations also reveal Finnair's general image to be among the very best in Europe.
Cargo services have been developed by adding cargo links to Central Europe and the Persian Gulf, enabling Finnair to offer efficient logistics chains in intercontinental traffic. The emphasis is on traffic between Europe and Asia. In November Finnair opened a weekly cargo route between Helsinki and Hong Kong.
Introduction of IFRS rules
Finnair's first IFRS financial statement will be for 2005. The key changes to accounting principles relate to pension arrangements, maintenance capitalisation of the Group's own fleet, maintenance provisions for leased aircraft, inventories, goodwill and market value testing, and financial instruments. Finnair will not yet apply hedge accounting IAS 39 standard to financial instruments for 2004. Operational leasing liabilities for Finnair aircraft in IFRS accounting will be treated as off-balance sheet liabilities as they have been in Finnish financial statement practice.
The total sum of shareholders' equity adjustments made for the opening IFRS balance sheet prepared for the transition date of 1 January 2004 has grown from that announced earlier due to updated pension liability calculations made by the insurance institution. The total sum of the Group's shareholders' equity adjustments reduces shareholders' equity by around 40 million euros. Shareholders' equity improves significantly in terms of pension liability during 2004, because the adjusted IFRS result for 2004 is better than the result according to Finnish financial statement practice. IFRS accounting principles have no substantial impact on the Group's solvency or capital structure.
Finnair will publish its first IFRS financial statement in the interim report for the first quarter of 2005. At the same time the opening IFRS balance sheet prepared for the transition date of 1 January 2004 will be reported. The first official IFRS financial statement will be published for 2005, when the IFRS financial statement for 2004 will be available for comparison.
Short Term Outlook
Price competition resulting from the market situation in the industry will continue to be intense. Overcapacity in the Finnish and Scandinavian markets will keep airlines' load factors low and create profitability problems for many.
Finnair's strong market position and product superiority are indicative of an effective strategy. The pricing reform introduced in autumn 2003 has proved to be a success in hard competition. The long decline in the average price has been halted and the price level for 2005 is expected to remain at last year's level. The advance booking situation seems encouraging, growth in demand is expected to continue and load factors will be higher than in 2004.
Growth in capacity is expected to be less than five per cent in 2005 and will be directed primarily at Finnair's Asian traffic, through the new Canton route and higher flight frequency in the summer, and at the expansion of flynordic's traffic. flynordic will open new routes in Scandinavia and elsewhere in Europe.
Finnair is preparing for the introduction of twelve new 76-seat Embraer E170 aircraft. The new aircraft will enable capacity to be flexibly allocated according to demand on each route. Embraer acquisition will replace the Boeing MD-80 and ATR 72 fleet, simplifying the fleet structure over the longer term and generating savings.
Capital investments in 2005 will be less than 100 million euros. The four Embraer E170 aircraft which will join Finnair's fleet between September and December 2005 will be acquired on operational leasing agreements. Investments will include the purchase of equipment required by the new type of aircraft.
The high price of fuel will burden profitability. Cost development is under control and the continuation of the operational efficiency programme will yield savings and new revenue. The long decline in unit costs will slow in 2005 owing to higher fuel costs, the introduction of the Embraer fleet and information technology investments.
The 2005 operational result is expected to be better than the previous year.
FINNAIR PLC
Board of Directors |