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(Corrects cost comparisons in paragraphs seven and eight toeuro cents, and not euros)
By Andrew Callus
PARIS, Sept 30 (Reuters) - With no deal in sight over pilotpay and up to 300 million euros ($380 million) of strike coststo absorb, Air France-KLM may need to rethink itsroute to viability.
As the airline restored its flight schedule to 98 percent onTuesday and pilots returned to work, its estimated cost of thetwo-week strike represents more than double the meagre 130million euro operating profit of Europe's second-largest networkcarrier by revenue last year.
The company suffered a loss in 2012 and has not paid adividend since 2008.
Like other traditional carriers, the Franco-Dutch group hasbeen squeezed in its long-haul business by competition fromMiddle East airlines, on shorter routes by the low-cost sector,and by industry overcapacity.
But its labour cost problem is particularly acute.
Research by Barclays analysts earlier this year showed thatamong European airlines, only Air France-KLM and SAS had staff costs higher than their fuel costs, accounting foralmost a third of total outgoings compared with around a quarteror less for other traditional players.
In addition, the research showed, Air France-KLM's overallpassenger unit cost per available seat kilometre (CASK),excluding volatile fuel costs, was the third-highest in Europein 2012, behind SAS and Spain's Iberia, at more than 7 eurocents.
That compares with just over 1 euro cent for the bestperforming low-cost player, Ryanair, and 2 euro centsfor Vueling, the Spanish low-cost airline bought last year bythe British Airways-Iberia combine IAG.
COSTLY AGREEMENTS
Hence Air France-KLM's plan to develop low-cost Transaviabrand, details of which were announced in September, triggeringa two-week pilots strike that grounded over half of Air Franceflights until the main pilot's union called it off on Sunday.
James Halstead, a consultant at Aviation Strategy, saidcostly French union agreements on pay and conditions were at theroot of its troubles. He and other analysts say buying aready-made low-cost business is a possible answer.
"Air France wants to have some kind of operation thatdoesn't have that sort of legacy environment ... you can seethat IAG is treating Vueling as a method of providing growth ina relatively efficient way," Halstead said.
In the meantime, the action by pilots worried Transavia willsuck away jobs and erode their own pay and conditions has killedoff any expansion of new Transavia hubs in lower-cost countriessuch as Portugal.
Analysts are already sceptical that Transavia can deliverthe 100 million euros a year of extra underlying profitmanagement is targeting by 2017. Without hubs outside France andthe Netherlands, that could be harder.
Although pilots are back at work, they gave no ground ontheir demands for a single set of pay and conditions for bothAir France and Transavia France - something management insistedlast week "totally opposes the principles of this model".
Some analysts also wonder if Air France should not retreaton domestic routes altogether, given Ryanair and easyJet alreadyenjoy strong positions in France and want to expand there.
"There could be a lesson from British Airways, which hasrecognised that it cannot be all things to all people and haswithdrawn from the UK domestic market other than on routesfeeding the Heathrow hub," said John Strickland, an independentaviation analyst.
Air France shares, which closed flat at 7.424 euros, haveslumped from a year's high of near 12 euros set in April. Theytrade on a multiple of 8.9 times prospective earnings, adiscount to a peer group average of 14.4 times, according toReuters data.
COST REDUCTIONS
Under a programme dubbed Transform 2020, Transavia wasearmarked to deliver about 100 million euros a year of extracore earnings before aircraft leasing costs (EBITDAR) by 2017,or more than a quarter of the total 380 million euros targeted,by ramping up to a fleet of 100 aircraft.
The rest of Chief Executive Alexandre de Juniac's planinvolves returning the lossmaking cargo arm to breakeven andimproving the profitability of its maintenance division.
Air France-KLM's EBITDAR in 2013 was 2.77 billion euros.
But Transform 2020 also assumes an overall reduction incosts of 1 to 1.5 percent a year in order to reach a return oncapital employed (ROCE) of between 9 and 11 percent by 2017, upfrom 2.9 percent last year.
It said it would do this partly by negotiating productivitygains with staff, a promise that looks difficult to achieve, atleast where pilots are concerned.
"We refuse to let Mr. De Juniac deliver his 11 percentreturn at the expense of employees," Christophe Pesenti, anAirbus A320 pilot, told Reuters at a demonstration in Paris.
Nor does full-blooded government backing for any futurebattle look likely, even though the Air France-KLM board, whichincludes representatives of 16 percent shareholder the Frenchstate, backed de Juniac's position after his concession onTransavia Europe.
During the strike the Socialist government, faced with pollratings and rebellious left-wing MPs, showed more desire to endthe strike than to put its weight squarely behind management.
Transport Minister Alain Vidalies questioned the wisdom ofthe Transavia Europe venture, just a day after de Juniac haddefended it at the height of the strike.
Hours later de Juniac caved in on hubs outside France,eliminating an important route for achieving possible savings.
"It is still hard to imagine Transavia can be quite aslow-cost as easyJet or Ryanair, said Halstead."Especially if they are running it from France." (1 US dollar = 0.7948 euro) (Additional reporting by Tim Hepher and Matthias Blamont;Editing by David Holmes)
