OREANDA-NEWS. Labour relations disputes resulting in pilot and cabin crew strikes are a key risk to European network carriers' transformation plans, Fitch Ratings says. The rise of low-cost carriers (LCCs) and greater competition from Gulf airlines has greatly increased pressure on network carriers to reorganise, including changing pay and working conditions. This increases the risk of further strikes, which could weaken financials already stretched by the highly competitive operating environment, although lower fuel costs should provide some relief.

The pilots' strike at Lufthansa's Germanwings on 12-13 February is a continuation of a series of strikes organised by the Vereinigung Cockpit pilots' union regarding retirement benefits and the airline's low-cost expansion plans. Air France-KLM also faced a 14-day pilot strike in September 2014.

We expect the European flagship carriers to continue implementing their transformation plans in 2015. But continuous strikes may delay their execution or limit the scale of changes, reducing the expected benefit. IAG is likely to be an exception, giving it an advantage over other European legacy airlines, as it was ahead of its rivals in transforming operations at BA and Iberia, and in acquiring Vueling.

The transformation plans aim to improve efficiency through cost-cutting, introducing more flexible labour agreements and restructuring short-haul routes, transferring point-to-point routes to low-cost subsidiaries. We expect these measures to lead to greater efficiency and to support higher margins.

Strikes can have a material negative impact on airlines' financials. We believe Lufthansa is better placed than its peers to absorb related costs due to its solid financial profile. Air France-KLM estimated the impact of the pilot strike on its 3Q14 operating profit at EUR330m, and cut its estimate for 2014 EBITDA by EUR700m from EUR2.2bn-2.3bn due to the strike and weakness in unit revenue. Lufthansa estimated the impact from strikes at EUR170m for the first 10 months of 2014 and cut its 2014 operating profit forecast to around EUR1bn from EUR1.3bn-1.5bn.

Lower oil prices can provide some support to profitability and mitigate the impact of strikes. But the effect depends on the companies' fuel hedging policies. Air France-KLM and Lufthansa use a balanced hedging policy. The former had 55% of consumption hedged for 2015 at end-3Q14, and Lufthansa around 30% at the beginning of February 2014. They should therefore gain the benefit sooner than Ryanair, which had 90% of its fuel requirements hedged for the year ending March 2016 as of February 2015.