AZ: Morgan Stanley assegna "equal weight".

[Paxromana]

ALITALIA: MORGAN STANLEY ASSEGNA 'EQUAL-WEIGHT'
(ANSA) - ROMA - Morgan Stanley si e' espressa sulla compagnia con una valutazione ''equal-weight'' e un fair value a 0,31 euro. Per la banca d'affari il fair value rispecchia le stime dopo la ristrutturazione al 2008, con ricavi in salita a oltre 5 miliardi. Un nuovo arrivo di capitali nel 2005 e se si consolideranno le attivita' esterne al core, secondo Morgan Stanley, potrebbe causare una revisione dei giudizi. Morgan Stanley rileva che il prezzo delle azioni Alitalia e' sceso quasi del 90% dai massimi del 2000 e resta sotto il 70% dal livello post 11 settembre. La banca d'affari considera che la compagnia italiana e' stata storicamente fra i vettori europei piu' inefficienti in relazione al taglio dei costi. Comunque, ha grandi margini per ridurre i costi operativi e razionalizzazione le operazioni. Il modello commerciale di Alitalia, secondo il report, ha sofferto della concorrenza da parte delle compagnie low cost e degli altri vettori che operano sul suo stesso network. Attualmente, poi, Alitalia non ha copertura per il carburante nel 2005 e se il prezzo del greggio rimane alto ancora a lungo, peggiorerebbero le previsioni di Morgan Stanley sul reddito netto nel 2005 ed oltre. La banca d'affari ritiene che il management deve far fronte ad una strada in salita nei prossimi quattro anni ed avra' bisogno del sostegno di tutte le parti coinvolte per far passare le misure vitali per la ristrutturazione. Dal punto di vista finanziario, la posizione di Alitalia resta difficile ed e' possibile che peggiori. Morgan Stanley afferma che e' difficile guidare gli investitori in una particolare direzione in quanto nei prossimi 12-18 mesi la compagnia puo' operare in modi differenti. Sul mercato domestico, c'e' ancora una buona opportunita' di business mentre sul medio-lungo raggio una razionalizzazione della presenza puo' portare a risultati migliori.(ANSA). RED
29/10/2004 13:01

[Paxromana]

Continua il rally in Borsa di Alitalia: più 6,3%

Alitalia sempre più in palla a Piazza Affari, con scambi fiume per oltre 26 milioni di euro, tornati ai livelli di quando, il mese scorso, veniva discusso il piano industriale. Il titolo della compagnia aerea guadagna il 6,3% a 0,251 euro, dopo che la banca d'affari Morgan Stanley ha dato la valutazione 'equal-weight', con un fair-value di 0,31 euro, che rispecchia, secondo la banca, le stime sui ricavi 2008 dopo la ristrutturazione prevista dal piano Cimoli

[marcogiov]

October 28, 2004

An Option on Restructuring

We initiate coverage of Alitalia with an Equal-weight-V rating
Alitalia’s business model has suffered a great deal from the introduction of low-cost competition and competitive actions of its larger network peers. Its future relies on the success of the 2005-2008 Restructure Plan, which we think is by no means guaranteed.
• Investment thesis: substantial upside potential for the brave; otherwise avoid We are reluctant to make strong judgements on the current business model as we are likely to see a very different entity emerge post restructuring. For the brave, attractive underlying dynamics exist, but we see safer ways to play the industry in other names.
• Valuation: price reflects option on success of restructuring plan
We currently assume a fair value of €0.31 per share, based on our normalised earnings estimate post the restructure in 2008. A possible capital injection in 2005 and successful deconsolidation of non-core business units may cause us to revisit our assumptions.
• Industry view: Cautious on European Airlines We believe that unrelenting competitive pressures, increasing product commoditisation
and regulatory issues will keep investment returns subdued for the medium term.

Summary and investment conclusion
We initiate coverage of Alitalia with an Equal-weight-V
rating and a fair valuation of €0.31 per share. Investor
focus for this stock is likely to hinge upon the restructuring
plan announced in September this year. We believe that
management faces an uphill struggle over the next four
years and will need support from all parties involved to
push through vital restructuring measures. We also see
success as by no means guaranteed. While unions have
accepted some of the redundancy and productivity
proposals, concessions were not as large as management
had hoped, and the risk of industrial action remains. In
addition, Alitalia’s financial position remains stretched and
is likely to deteriorate even further, on our estimates.
The shares have an option-like valuation. The future of the
company seems to be a binary outcome for investors —
either it survives and regains some degree of value, or folds
with equity becoming worthless. It is difficult to guide
investors in a particular direction — this company could
look and operate very differently in 12-18 months’ time.
For the brave investor, we see attractive underlying
fundamentals for a restructured flight operations company.
There is still good domestic business within Italy and
rationalisation of medium to long-haul routes could result in
far improved profitability (and perhaps eventually an
invitation to partner with Air France-KLM, provided other
aspects of the business also improve). However, until we
obtain further clarity on the new business models and their
financial structure, we see no need to be in the stock.
Valuation: tough to get a clear picture of company
Our fair value calculation uses available company data and
about 70% of the cost reductions targeted in the Alitalia’s
2005-2008 business plan. It does not, however, capture the
possibility of business separation and other potential
changes and enhancements to the capital structure. Our fair
value is based on our normalised EBIT margin estimate at
the end of the restructuring phase in 2008. In our modelling,
we assume the company can reach approximately 5%
margins by 2008. This is on our assumed revenues of
€5,035 billion.
We then add our assumptions for depreciation and lease rentals to arrive at a normalised
estimate for EBITDAR. We apply a peer average historical
EBITDAR multiple of 6 to our 2008 estimates and subtract
adjusted net debt (for lease rentals). On this analysis we
arrive at a fair value of €0.31 per Alitalia share.
Alitalia’s original 2004-06 Business Plan targeted an
EBITDAR margin of between 15% and 17% (see Exhibit 1),
which seemed overly ambitious given the company’s track
record. We assume the company reaches this target in 2008
after implementation of the new Business Plan 2005-2008.

Key investment positives

Price already reflects limited value: Alitalia’s share price
has fallen almost 90% from its highs in 2000. It remains
down 70% from the bounce post September 2001. As we
forecast substantial losses for both this year and next, it is
difficult to benchmark the Group against any of its peers in
a meaningful way. We believe the market has reflected this
in the current price — by pushing the shares down to
historical lows.
Potential upside from restructure could be material: If
management’s new Business Plan 2005-2008 can be
implemented successfully, the potential upside from today’s
depressed earnings level is material, in our view. Alitalia
has historically been among the most inefficient of the
European network carriers in terms of cost cutting and has
significant room to reduce operational costs and rationalise
operations.
Management in place has useful experience: a new CEO
in July, combined with operational management from one
of the most successfully restructured airlines, Continental,
has provided Alitalia with a ‘fighting’ chance to achieve a successful restructure, in our view. New staff agreements
have been negotiated and new cultural practices are already
being introduced into the business.
Transformation of labour relations: Alitalia has a history
of strikes and difficult management/union relations.
However, with the new labour agreement negotiated in
September, it appears the company has perhaps overcome
this hurdle to some extent. The employee/union recognition
of the problems that Alitalia is facing, and the actions
needed to address these issues are among the biggest steps
to reinvigorating the company, in our view.
Strong Italian market presence: Alitalia is the largest
operator at both Milan Malpensa (MXP) and Rome
Fiumicino (FCO) airports. It accounts for more than 60%
of seats offered and transport movements at Malpensa and
has more than 50% of the seat capacity offered at Fiumicino.
In addition, Italy is the largest generator of domestic traffic
among the major European nations. This should provide
Alitalia with a strong support base of traffic following the
proposed restructure.

Key investment risks

December 2003, the price for jet fuel has risen by more
than 84%. The company is approximately 25% hedged
through December 2004 but has no cover for 2005, which
places it last among European carriers (in terms of relative
hedging coverage) along with SAS. The company is also
exposed to the growing ‘crack’ spread on jet fuel — which
has risen from US$7 to US$15 in the past 12 months. If
fuel prices remain higher for longer, this is likely to put our
net income assumptions at risk in 2005 and beyond.
Long-haul competition. Competition on international
routes remains high, with most Italian international
travellers still preferring foreign airlines, and Alitalia’s
domestic services are under increasing pressure from the
subsidiary businesses of larger network peers (for example,
Lufthansa’s Air Dolomiti). Adverse industry conditions
have made it even more difficult this year.
Low-cost competition. Alitalia has started to feel the
effects of low-cost competition. The pressure is unlikely to
be alleviated anytime soon and Alitalia’s relative cost
disadvantage is there to exploit. Expansions to capacity at Milan, Rome and Venice airports will only further
encourage new entrants into the market, in our view.
Risk of the Restructuring Plan. There are many things
that can go wrong with the implementation of the new
Business Plan. Relations with unions are still being
developed and Government provision of welfare to
displaced workers will be key. Changes in the
composition of the European Commission in November
may also bring a change in attitudes to the classification of
‘state aid’. In particular, the deconsolidation of the AZ
Servizi business and proposed sale of a 49% share to stateowned
conglomerate Fintecna may meet tough regulatory
hurdles.
AF/KLM — integrating Alitalia is not on the agenda
for at least a few years. Calls made by the Italian
government to include Alitalia in the merged group have
generated muted responses. Both Air France and KLM
have made it clear that Alitalia has to get over a number of
hurdles before joining the alliance. As discussed earlier,
we believe that restructuring will take several years and
success is not guaranteed. We do not expect Alitalia to
join the merged entity for the foreseeable future. However,
attracting private investors will depend heavily on the
success of the restructuring plan, in our view.

Valuation Summary

Alitalia’s operational performance has been affected by
wide-ranging industry difficulties due to overcapacity and
yield pressure. In addition, Alitalia’s first-half 2004 was
negatively affected by increases in capacity from low-cost
operators (primarily Ryanair and easyJet) and tense
negotiations with all major union groups — pilots, cabin
crew and ground staff. This was compounded by traffic
delays at the key hubs of Rome and Milan.
Despite the many risks associated with Alitalia’s
restructuring programme (some would see this as a good
reason to avoid the stock), we are initiating coverage on
Alitalia with an Equal-weight-V as the stock is trading close
to our fair value. We also believe the company has a
chance to overhaul its operations significantly and
restructure its capital and ownership base.
However, until such time as we obtain a clearer picture of
the new entity, we must work with the available company
data and the basic cost reductions targeted by the Business
Plan 2005-2008. Among our key assumptions are:
1) We do not expect a dramatic short-term upward breakout
in earnings — on the contrary, we expect the next
three years to be tough for Alitalia, with sizable net
losses. We believe these expectations are similar to
those of the current management team.
2) Many of the new initiatives as part of the Business Plan
are going to be difficult to implement, in our view.
Alitalia is at a structural disadvantage to low-cost
operators in terms of unit costs and to network peers in
terms of scale of operations. We have assumed only
moderate cost savings from operations and labour
reductions. We assume the groups can achieve about
70% of the targeted value of reductions in our numbers.
3) With currently low short-term earnings visibility in the
airline industry and rising fuel prices, there remains
significant near-term earnings risk, in our view.
Our fair value calculation is based on our normalised target
EBIT margins for the company at the end of the restructure
phase in 2008. In our modelling we assume the company
can reach approximately 5% margins by 2008. This is on
our assumed revenues of €5,035 billion. We then add our
assumptions for depreciation and lease rentals to arrive at
normalised estimate for EBITDAR. We apply a peer
average historical EBITDAR peer multiple of 6 and subtract
adjusted net debt (for lease rentals). On this analysis we
arrive at a fair value of €0.31 per Alitalia share. At current
trading levels the market appears to be capturing most of
these assumptions.
Risks to fair valuation assumptions
Industry risks include: economic downturn in 2005,
geopolitical events, further increases in oil prices, currency
movements, more overcapacity and more aggressive
competition from low-cost airlines.
Risks specific to Alitalia include: the balance sheet
deteriorating to dangerous levels during the winter period
under a worst-case scenario (involving cash burn rates
higher than the €400 million loan can cover); negotiations
with staff on cost savings could hit ‘turbulence’,
jeopardising the cost savings plans; the EU may place
conditions on financial restructuring loans and
deconsolidation plans; potential breakdown of AF/KLM
current codesharing partnership. On the positive side, the
company could achieve greater cost savings and headcount
reductions than we forecast.

EU and Government Intervention in Restructure

Alitalia’s current position illustrates how, in Europe,
industrial policy comes in different flavours and yields
varying results. In some scenarios, it appears a measured
intervention is more effective. A decade ago, Air France
was also in severe financial distress in need of government
assistance. In the mid 1990s, Paris provided the equivalent
of €3 billion to Air France. It developed an airport policy
that helped Air France solidify its position at its Charles de
Gaulle hub, and brought in a quality management team and
let them do their job largely unencumbered. Air France’s
chief executive, Jean-Cyril Spinetta, has been in office
since 1997.
By contrast, Giancarlo Cimoli is Alitalia’s third CEO this
year. The government has changed three times and the
transportation minister has changed four times over the last
10 years. Over the years, the Italian state has chosen to
pour money into Alitalia whenever the carrier has been
close to collapse. In the past 15 years, Rome has rescued
the company seven times, giving the carrier access to
nearly €3 billion in extra funds.
The government has also intervened in other ways, issuing
orders that redirected competitors’ traffic to guarantee
Alitalia’s dominance of profitable routes. The intervention
was so blatant that the European Union stepped in to
reverse the policy in August this year.
Rome’s management of its big companies mirrors a deeper
divide in the Italian economy. The corporate landscape is
littered with large-scale failures or companies in financial
difficulties, including cash-strapped Fiat Auto SpA. Yet it
is home to the world’s sixth-largest economy, powered by
a hive of dynamic small businesses. Many of these small
businesses thrive in spite of one of the highest tax burdens
in Europe, poor public services and a state that still has a
tremendous presence in the economy.

Another shot at restructuring

The Alitalia Business Plan 2005-2008 has been sent to the
European Commission for approval, but the Commission
itself is set to be replaced on November 1 and it is
somewhat uncertain as to whether the outgoing executive
can examine it in time to allow Alitalia access to a €400
million bridging loan from the Italian state. The rescue
plan calls for dividing the national carrier in two, with AZ
Fly responsible for flight activities and AZ Service
handling ground activities.
The Italian government has also stated it will pass a decree
to extend boosted welfare benefits to airlines to ease the
Alitalia layoffs. Until now, the airline industry has not
been covered by the state-sponsored welfare payment
system. Alongside state-owned Fintecna’s proposed
purchase of 49% of AZ Services, the governmentsponsored
unemployment benefits could set off alarm bells
at the European Commission — the executive arm of the
European Union, which has said that Italy cannot give
Alitalia more state aid beyond the €400 million
government-backed loan it authorised in July. Labour
Minister Roberto Maroni said the welfare benefits measure
would not violate EU rules, however.

Competitor response

Earlier this month, eight European airlines stepped up the
pressure on Italian flag carrier Alitalia’s restructuring plan,
saying they had filed a complaint with the European
Commission against the proposal. Germany’s Lufthansa,
British Airways and Spain’s Iberia were among the airlines
that told the Commission that Alitalia’s restructuring
violated state aid rules and threatened competition.
"Further aid will severely hinder the much-needed
consolidation of the European airline industry and will
constitute a major distortion of competition," the airlines
said in a joint letter to the commission. The letter was also
signed by Austrian Airlines, Finnair, Germany’s TUI’s
low-cost carrier Hapag Lloyd Flug, Scandinavian Airlines
and state-owned TAP-Air Portugal. It followed a similar
complaint by the European Low Fares Association.
Alitalia, on the other hand, said that the plan created the
conditions in the future for it to join the giant European
carrier being created through the merger of Air France and
KLM. Interestingly, neither the French nor Dutch carrier
signed the letter to the European Commission.

Business Model Overview
Current business profile

The Alitalia Group generates revenues of about €5,000
million and carries 22 million passengers a year. It has a
fleet of around 180 aircraft and more than 22,000
employees in Italy and abroad. The business model it
adopts is centred on core business passengers and cargo,
although it has other operations in ground handling and
engineering services.
Passenger operations: The system is centred on the Rome-
Fiumicino and Milan-Malpensa hubs, and offers a range of
destinations in Italy and all over the world. Together with
the SkyTeam partner airlines, Alitalia offers 8,000 flights a
day to over 512 destinations in 114 countries. The
division’s workforce is made up of about 2,500 staff —
1,500 in Italy and 1,000 abroad.
Cargo operations: Alitalia’s cargo division employs
around 700 people working in 50 offices all over the world.
Apart from ‘ordinary’ transportation, they deal with
specialised items such as racing cars, fashion, artwork,
valuables, as well as dangerous, voluminous or heavy
objects, and perishable goods. Alitalia Cargo uses the space
available on the Group’s passenger aircraft, and also has
two Boeing 747 All-Freighters that can carry payloads of up
to 100 tonnes. In addition to the network of airports served
by the passenger fleet, there are several all-cargo
destinations. In August 2001, Alitalia Cargo & Logistics
joined the world’s largest alliance of cargo carriers:
SkyTeam Cargo.
Engineering & maintenance: This area manages and
develops maintenance and servicing activities for the
Alitalia Group fleet, overseeing the quality system and
relationships with captive customers and third parties. The
overall workforce consists of about 5,000 people working
around the clock in shifts. They provide services to the
Alitalia fleet and those of third-party customers.

Proposed restructure

The proposed restructuring of the company is substantial
and involves splitting the loss-making airline into two units
— AZ Fly, comprising flight operations, and AZ Services,
comprising ground services business. Under the agreement,
the Italian economy ministry, which holds a 62% stake in
Alitalia, will keep a minimum stake of 30% in AZ Fly. The
rest of the shares will be sold to institutional investors in a
capital increase at the beginning of 2005. Alitalia said AZ
Fly will have a controlling 51% stake in AZ Service, with
the remaining 49% going to state-owned holding company
Fintecna. Alitalia’s CEO has said that the €400 million loan,
once released, will allow the company to operate throughout
the winter, while it restructures.
AZ Fly will deal with Alitalia’s core business, namely:
marketing and network; flight operations, sales and
distribution; product integration and delivery; cargo;
corporate activities and governance supervision of activities
concerning the AZ Services separation.
AZ Services will deal with: engineering and maintenance
(line, light, heavy, engines, components and engineering
services). This will be done jointly with two controlled
companies, Alitalia Maintenance Systems (of which
Lufthansa has a 40% share) and Atitech. It will also take
care of ground handling via the Alitalia Airport company
and Information Technology. Other activities will include
administration, planning & control, human resources,
centralised business services (facility management) and the
call centre.
After opening a €400 million state-guaranteed credit line
with Dresdner Kleinwort Wasserstein this month, the
company also specified that it would seek up to €1.2 billion
in a recapitalisation early next year. This is less than the
€1.5 billion Alitalia chief executive Giancarlo Cimoli said
might be necessary in parliamentary testimony.
With the cash call, Alitalia has pledged that the
government’s stake will fall to 49% from the current 62% as
it subscribes to less than its quota of the recapitalisation.
That was one of the European Commission’s requirements
in authorising the €400 million loan. Alitalia said that it
would decide by December 15 when to call a shareholders’
meeting on the capital increase. As part of the plan, statecontrolled
holding Fintecna would purchase 49% of
Alitalia’s services business. Alitalia also said that both the
€400 million loan and the airline’s €1.6 billion in mediumand
long-term debt would be transferred to AZ Fly, as the
flight unit will be called. Some Financial Times reports
early in the process suggested the debt could be shifted to
the ground services unit to make AZ Fly more attractive to
investors. This has since been denied by the company.
Meanwhile, European Transport commissioner Loyola de
Palacio will end her term on October 31. It is unlikely a
formal judgement on the funding will be made before her
exit. The Commission has asked for further information
regarding the structure of the two businesses — in particular
it has requested additional details about the state-owned
Fintecna entity. It has made repeated statements that the
plan must not contain state aid — although having observed
the decision on Alstom, the Italian government should feel
quite confident of a positive resolution.

Labour agreements in place

Pilots: Alitalia reached an agreement over employment
terms and working hours with the six union organisations
representing the company’s pilots. The main points of the
agreement were signed on September 14, 2004. These
include increasing the variable portion of salaries from 13%
to 22% as an incentive to fly more, as opposed to the fixed
portion that has gone down from 86% to 78%; raising the
upper limit of flying hours to 900 a year, with an increase in
activity of 22% for medium- and long-haul flights. The
agreement places Alitalia at productivity levels equal to or
better than other major European airlines. It regulates crew
composition and operational flexibility with the aim of
optimising deployment of pilots during periods of peak
activity, and simplifies the contractual structure by
combining a number of clauses.
Ground staff: On September 16, an agreement was reached
with the five union organisations representing ground staff.
The agreement renews the collective employment contract,
bringing certain aspects up to date, but without changing
salary levels and excluding index-linked pay increases for
the period 2004-06, as well as other smaller payments. In
addition, an agreement was reached over excess personnel
as a result of an overall review of programmes already
under way. The number of redundancies was set at 2,500,
while still maintaining the levels of efficiency required.
The agreements will lead to savings of approximately €150
million a year.
Flight attendants: On September 18, the new flight
attendants’ agreement was signed by Alitalia and the seven
union organisations representing them. The agreement
regulates the employment of flight attendants on more
competitive terms, improving productivity by 29% and
increasing flying hours from 590 to 763 a year, with the
upper limit extended from 770 to 900, in line with other
major European airlines. In addition, the standard number
of cabin staff on board has been lowered. The number of
personnel to be based in Rome and Milan has also been
recalculated. The agreement renews the employment
contract for the four-year period 2004-07 without changing
the salary terms and excluding index-linked increases for
inflation. The variable portion of the salary linked to flying
hours increases from 14% to 23%. Agreement was also
reached over redundancies, set at 900 people drawn from
the various categories. The agreement will lead to savings
of approximately €80 million a year.

Business Plan 2005-2008

At the July Board meeting, President-CEO Mr. Cimoli
described the guidelines for the 2005-2008 Business Plan
and the principles behind the organisational changes
required to improve efficiency. The formal plan was
approved by the Board in September. The plan foresees
achieving economic balance by the end of 2006, and
reaching an EBITDAR which will be in line with that of the
best operators in the industry. These measures will make it
possible to reduce costs progressively throughout the period
of the Plan (roughly €750 million in 2006, and €1 billion in
2008).
The Plan calls for an initial phase of recovery (2005-06),
in which the primary objectives are to ensure the company’s
ongoing operations, to bring about economic equilibrium
and to reach an EBITDAR margin comparable with that of
other major airlines. This phase does not foresee
investment in fleet expansion, but rather a significant
increase in the use of aircraft and an across-the-board rise in
the productivity of all sectors, accompanied by a radical
review of the cost of procuring goods and services.
Greater efficiency is also targeted via a marked recovery in
workforce productivity. Indeed, the Plan calls for savings
in labour costs of around €280 million by the end of 2006,
involving around 3,700 redundancies.
It will subsequently be possible to begin the actual relaunch
of the company (2007-08) through the acquisition
of new long-haul and narrow body aircraft. The availability
of new aircraft will help to increase capacity offered further
and will optimise production factors. Alitalia plans to
establish itself as a “highly efficient network carrier”.
Specifically:
• Increased production efficiency in the intercontinental
sector will enable the Company to expand its
destination portfolio and provide more flights to
markets already served.
• In the domestic and international sectors, the pursuit of
a drastically lower-cost base will lead to significant
reorganisation of the production model to sustain
capacity levels and develop activities in line with the
potential demand from targeted traffic areas.
Mr. Cimoli also stated in a subsequent Board meeting that
cuts in purchasing costs are estimated at more than €200
million during the first two years, of which over €100
million will take place in 2005. Increased productivity in
all operational areas will lead to an improvement of €320
million. By the year 2006, management expects the
commercial area to produce a further €250 million. Under
the Plan, 16 new routes are planned for 2005 and TKO
activity will increase by 13% during 2006, in line with fleet
development. The two-year period from 2007-08 will focus
on fleet expansion and the start-up of several new routes,
leading to an overall growth in TKO of 28% compared from
today’s levels.
This new positioning will be accompanied by a change in
the company’s organisational set-up to make it more
streamlined, efficient and more strongly customer-oriented.
As far as realignment of the company’s financial position is
concerned, the Business Plan envisages a drastic reduction
in debt ratio (leverage) during its time span. In the period
prior to full implementation of the measures and the
planned recapitalisation, the Plan foresees the immediate
use of the bridging loan of €400 million guaranteed by the
Italian State to meet treasury needs in the coming months.
The recapitalisation, scheduled to take place during the first
part of 2005, along with the company’s renewed capacity
for self-financing and recourse to loan markets, will
necessarily contribute during the 2005-08 time span to
meeting the needs set out in the Plan, and to obtaining
adequate margins of economic flexibility leading to
substantial improvement in the financial position.

Outcomes of October board meeting

The Board approved the 2004 first-half report for the
Alitalia Group, showing a net loss of €620 million. The
main figures included an extraordinary item arising from the
allocation of €289 million for the costs involved in dealing
with the redundancies as set out in the Business Plan (€167
million) and the differential values relating to the “AZ
Services” operation.
The Board agreed to hold the extraordinary meeting of
shareholders by December 15, 2004 (the exact date will be
announced at the next Board meeting) to decide on
increasing the company capital. Shareholders will be asked
to approve a proposal allowing the Board members to take
decisions about increasing the capital in one or more stages,
to the amount of €1.2 billion, as set out in the 2005-2008
Business Plan. The Board also agreed to bring forward the
meeting planned for November 12 to November 11, 2004;
the agenda for this meeting will include approval of the
quarterly report as of September 30, 2004.

Earnings, Balance Sheet, Cash Flow Analysis

Key Messages
• We expect net income to remain negative for the
next three years. Despite the cost reduction
programme over the coming years, we expect fuel price
rises to affect the bottom line.
• 2008-09 should see the effect of the Business Plan;
labour efficiencies and other unit cost reductions
should help to boost earnings and cash flow.
• Alitalia faces an uphill battle; low-cost carrier
competition is likely to remain a threat to the domestic
operations.
During 1Q04, Alitalia’s seat-load factor decreased by 1.5
percentage points to 72%. We expect its capacity (available
seat kilometre or ASK) to grow by 2% in 2005, with a
revenue passenger kilometre (RPK) increase of 3% and a
yield decline of 4.0%. Combined with Alitalia’s
expectation of a traffic increase of 4%, we expect passenger
revenues to decrease by 1% during 2005.
For 2005, we expect a total unit cost decrease of 2.0%,
driven mainly by additional restructuring and the deferral of
fleet deliveries. We expect the company to be able to
record unit cost decreases through 2006-07. Our forecasts
for unit cost declines could be jeopardised by oil prices
remaining at current levels. We think the majority of future
aircraft deliveries are likely to be delayed until the end of
the current Business Plan period. Cash advances from the
€400 million loan will be channelled into day-to-day
operations during the winter months.
We forecast average annual EBIT margins will reach over
5% the year after the completion of the Business Plan. We
believe that Alitalia has a reasonable chance to improve
competitiveness in its domestic operations, which should
help to drive margin expansion. As regards cost reduction,
Alitalia’s poor cost structure over the last two to three years
relative to both low-cost operators and network peers has
resulted in substantial market share losses — we think it
will have its work cut out to reduce costs in line with its
peers. It will be increasingly important for Alitalia to
become involved with alliance partners such as Air France-
KLM to help diversify its network structure and combat the
competitive dynamics within its European operations.
Free cash flow
During 1Q04, Alitalia generated operating losses of €206
million. Its net cash position increased to €(259) million
from €(515) million in December 2003. This year, we
expect Alitalia’s net cash position to deteriorate further. For
the moment, we think management will opt for a large
proportion of operating leases, which should result in low
levels of capital expenditure, while reducing EBIT through
higher lease payments. A potential credit line of €400
million from the Government could help manage this cash
position over the winter.
A balance sheet in disarray
In 2003, 30% of Alitalia’s fleet in terms of aircraft units was
operated under off-balance-sheet lease agreements.
Capitalising Alitalia’s operating lease payments (seven
times lease rental payments), we estimate Alitalia’s adjusted
net debt level to be around €3.8 billion — approximately
400% gearing. In addition, years of heavy losses and poor
capital management has left the group with little positive
equity. The proposed recapitalisation in 2005 would help to
improve the composition of the balance sheet and realign
the capital base of the company.
Current indebtedness
To comply with instructions from Italy’s Securities and
Exchange Commission (CONSOB), Alitalia is presently
required to issue a monthly statement of indebtedness with
the Italian regulatory authorities. We present the latest
statement from the month of August in exhibit 14.

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