SCOTTISH EXECUTIVE

[Previous] [Contents] [Next]

Final Report: Options for the Ferry Services Between Gourock and Dunoon

7. FINANCIAL ANALYSIS

7.1 Methodology

In this section, we analyse the revenue and balance sheet performance of the two operators. This analysis forms the starting point for the financial assessment of future options for service delivery.

Western Ferries operates only one route and, therefore, analysis of its revenues and costs is relatively straightforward.

CalMac accounts for its revenues on a route-by-route basis. As regards multiple tickets, CalMac allocates revenues from multiple ticketing in the same ratio as the relative fares which apply on each of the routes covered by a joint ticket. This is based on the assumption that buyers will travel on all legs of a Hopscotch ticket.

CalMac's costs have traditionally been accrued by vessel and by pier as cost centres. Where vessels are deployed on more than one route, the costs and revenues are allocated between them. Costs are allocated in proportion to the operational hours spent on each route.

We originally adopted this as our basis for producing direct ship costs for the individual route of Gourock-Dunoon. However, CalMac concluded that this method of cost allocation overstated costs, as the operational hours included non-productive time spent by certain vessels which should be allocated across the whole network as a reserve fleet costs. The approach finally adopted was to use:

• average costs per ship multiplied by 1.2 ships, which is the number of ships nominally attached to the Gourock-Dunoon route;
• With the addition of 1/13 of the reserve fleet costs of £1.024 million, since there are 13 routes.

The difference between the two methods of arriving at direct ship costs is a decrease in costs of £561,000 per annum.

In terms of indirect shore costs, the correct allocation of head office overheads was also not straightforward. CalMac's head office overheads are allocated on the basis of whether a route is designated a major or a minor route. This definition is a somewhat subjective one, based on a decision by the management team of what the respective markets will bear. CalMac has a total overhead of £4 million and could, of course, allocate its overheads in any proportions it chooses to any of its routes. Gourock-Dunoon is currently designated a major route and, therefore, bears overheads of £400,000. Were it to be designated a minor route, the charge would fall to £ 100,000. However, there is a third possibility for the treatment of these overheads: CalMac considers that, if it were to withdraw from the Gourock-Dunoon route, its central costs would not reduce, or be recovered on other routes. Head Office overheads would, accordingly, be deemed sunk costs which should not be taken into account at all in any option appraisal. It can, therefore, be seen that the allocation of overhead is a significant factor of difference, which has a material effect on all of the following option costings.

To complete the route accounts for Gourock-Dunoon, we added the costs of the two individual piers.

7.2 Cost Structures

Applying this methodology, we have estimated the cost structure of the two current operators on the route, which is set out in Figure 7.1 below. The Figure shows that the main differences in service delivery costs are in direct ship costs and indirect shore costs.

The differences in direct ship costs can be ascribed to the different labour costs caused by different manning systems. As has been stated, CalMac operates at a higher level of crew.

With respect to indirect shore costs, it will be seen that the administrative overhead ascribed to CalMac of £400,000 is higher than Western Ferries' total administration costs of £308,000, made up of..

• administration costs of £205,000; and
• a management charge of £103,000 payable by Western Ferries to its management company, Stirling Ship management Ltd.

Figure 7.1 Operators' costs structures on the Gourock/Dunoon route (1997)

Sources: CalMac cost centre reports and Western Ferries Profit & Loss accounts

The following points may be noted from the above analysis:

• passenger income makes up nearly half CalMac's total revenue and less than one quarter of Western Ferries';
• Western Ferries' direct ship labour costs are just under half of CalMac's as a proportion of total revenue. CalMac's repair costs are also higher;
• CalMac pays £279,000 in berthing and traffic dues to Argyll and Bute Council for Dunoon Pier. By contrast, Western Ferries' equivalent charges are incorporated in its rent of £69,000 and its port charges of £21,000, a total of £90,000;
• CalMac's results are shown without the benefit of grant income, except for a small £11,000 capital grant. Revenue grant ascribable to this route is calculated at £800,000. If the grant was taken into account, it would turn an £852,000 operating loss into a £524,000 operating loss (before depreciation and interest).

In summary, the cost differential between the two operators is attributable to differences in:

• staffing levels and manning agreements;
• ship repair costs;
• pier dues; and
• administrative overheads.

By way of comparison, we also analysed the cost structure on CalMac's Wemyss Bay/Rothesay route. The analysis indicates that the cost structure on this route is broadly similar to CalMac's cost structure on the Gourock/Dunoon route, although direct shore costs represent a slightly lower proportion of turnover, suggesting that the berthing dues payable at Dunoon represent an additional burden for CalMac. In addition, depreciation on the Wemyss Bay/ Rothesay route represents a slightly higher proportion of turnover because Wemyss Bay/Rothesay has more operating capacity than Gourock/Dunoon.

The similarity of the two cost structures suggests that CalMac's costs on the Gourock/Dunoon crossing reflect its operational standards as set by legislation and under agreement with unions, rather than any specific or unusual characteristics of the route itself.

While the above analysis relates to the pre-tax figures, it should be pointed out that Western Ferries generates around £ 100,000 in tax payments to the Government a year.

7.3 Comparative Financial Analysis

Figure 7.2 overleaf provides key financial data for a sample of eight British ferry operators, including Western Ferries and CalMac.

Figure 7.2 Benchmarking costs structures

Source: companies' published accounts

The eight are very different in their size and structure. The largest company in the sample is the Stena Line Ltd, the holding company for all Stena group ferry services, which had a turnover of £360 million in 1995. The smallest is Sea Containers (Scotland) Ltd, a subsidiary of Sea Containers, which had a 1995 turnover of £0.4 million. However, despite this wide spread in turnover, certain common themes emerge regarding the financial characteristics of British ferry operators:

• they have low gearing. Only two companies in the sample had a debt/equity ratio above unity - Sea Containers (Scotland) Ltd and P&O Scottish Ferries - both of which were regional subsidiaries supported by their parent company's balance sheet;
• all the companies had low operating margins, with an operating profit of between 0. 1 % and 16% of turnover;
• all except Sea Containers (Scotland) Ltd and CalMac had ratios of turnover/assets in excess of 100%: i.e. their annual revenues exceeded the capital invested in the company;
• most of the companies showed modest growth in their activities compared to the preceding year, but their net investment was low or negative. Exceptions included the Isle of Man Steam Packet Company, which invested just over £2 million in a SeaCat to meet its service requirements, and Western Ferries which invested approximately £1 million in new capacity to serve the McInroy's Point/Hunter's Quay route in 1995/96. CalMac was also a net investor.

In summary, ferry operations are low margin, cash generative businesses, operating in a mature market which exhibits slow growth. Their profitability depends critically on squeezing high turnover out of their assets. Their free cashflow is not sufficient to finance large capital expenditure programmes. Investment is mainly to replace existing capacity rather than to expand capacity, with a number of operators introducing high-speed craft such as SeaCats to replace conventional ferries.

[Previous] [Contents] [Next]