The airline industry faces its gravest crisis. Within a matter of a few weeks, our previous worst-case scenario is looking better than our latest estimates. Without immediate government relief measures, there will not be an industry left standing
BY GILBERT NG’ANG’A
The past three years have certainly been a bloodbath for Kenya Airways, or KQ as the national airline is known by its international code. And possibly, the coming few months to the end of 2020 hold the biggest sway on whether the airline will stay in the skies in the future.
Like other airlines globally, the Covid-19 pandemic has badly battered the business, worsening its already atrocious credentials.
Latest data shows that across the world, 23 airlines have collapsed since February following the international travel restrictions introduced to curb the spread of the disease.
Locally, KQ has been one of the hardest hit businesses following the grounding of both domestic and international flights since April. This has not helped the airline, which has been teetering on the brink of collapse. In fact, many independent analysts and travel experts predict that KQ is facing an imminent shut down, especially so if the government—the biggest shareholder—does not rescue it from a biting financial disarray.
So, what exactly is the state of KQ? How did we get here? What lies ahead for the airline? What must be done to save it from further ruin?
The Nairobi Business Monthly seeks to answer the four questions as KQ hinges its hope on resumption of travels in and out of Kenya, scheduled for August 1.
For the airline, a combination of factors such as flawed business strategies, cutthroat competition, mismanagement and now Covid-19 have conspired to bring down one of East Africa’s most strategic company in respect to air travel.
In the results released on May 26 for the full year ending December 2019, KQ sunk deeper into the red as operating costs rose, at the same rate as the revenues. The airline posted a Sh12.98 billion net loss as increasing operating costs offset growth in revenues.
The Group saw a 12.4% increase in operating costs, driven by the increase in capacity deployed and an increase in fleet ownership costs attributed to the return of two Boeing 787 aircraft that had been subleased to Oman Air, said Mr Michael, chairman Joseph during the announcement of the results. Comparatively, the carrier’s revenue increased by 12.4% to Sh128.31 billion on improved passenger and cargo numbers due to expansion of network.
“Although we realized improved revenue growth in the year, profitability was constrained by the increased competition in the airline area of operations, which, in turn, has increased pressure on pricing in order to remain competitive. The board and management are undertaking several key strategic initiatives to improve the financial results of the Company going forward,” said Mr Joseph.
But this is not new for KQ. The loss-making airline, which is 48.9% government-owned and 7.8% held by Air France-KLM, was privatised 24 years ago but sank into debt and losses in 2014. It has not recovered since then.
On March 31, KQ announced that it had applied for an emergency bailout from the Treasury. The airline halted international flights after a State order on March 22 to cancel all cross-border passenger flights. The order effectively cut off Kenya Airways’ flow of new revenues at a time when it had no cash reserves.
“We have requested the Government for financial support through a bailout as at the moment we are cash strapped by the fact that we are no longer in operation, except for a few local flights. We have also sought for other incentives like tax breaks and waiver of navigation and landing fees at airports,” Kenya Airways CEO Allan Kilavuka told the media on March 31.
The national carrier needs money for the maintenance of the grounded planes, payment of staff salaries and settlement of utility bills like security, water, electricity and parking fees.
On April 22, Kenya Airways’ share price dropped below the Sh1 mark to trade at Sh0.97 at the Nairobi Securities Exchange (NSE), sunk by pressure from the airline’s financial woes that have been worsened by international travel restrictions. The turn of events highlighted the woes KQ is facing. On July 3, Kenya Airways shares were suspended from trading on the Nairobi bourse for three months as the process of State takeover entered a crucial stage.
The return of KQ to the NSE now lies in the hands of Parliament given that the passage of the National Aviation Management Bill 2020 will see government take back full control of the national carrier by October and delist it.
Under the plan, the government, which owns 48.9% of KQ, is expected to buy out the remaining holders of 51.1% of the shares, and form Aviation Holding Company to run the national carrier and Kenya Airports Authority (KAA).
“We are ready to complete the transactions once Parliament passes the Bill,” Treasury Cabinet Secretary Ukur Yatani said on June 26. A lot of work has been done in the background including striking an agreement with KLM and talks are advanced with banks on conversion of their equity to bonds.” Yatani was reluctant to grant KQ its request for a Sh7 billion emergency bailout, saying the State was keen on the long-term rescue plan.
“Kenya Airways need to remain afloat but it is also important to look at structural challenges because what is happening now is more than the business environment” he added.
Despite being a private company, the Government has often shouldered the burden of keeping the airline afloat.
The restructuring as proposed in the Bill would result in delisting of KQ, overhaul of the balance sheet and its financial liabilities. The restructuring could reduce the risk profile of KQ, which would aid in renegotiating KQ’s aircraft leases, ultimately reducing the operating cost. Operating under holding company, the airline would enjoy concessional rates of taxation, which would facilitate cost-competitive tickets. Currently, KQ pays ground rent, navigation charges, landing and parking fees, service recovery charge and a fuel sub-charge that have an operating cost implication.
The high operating cost is charged to KQ passengers through expensive ticket prices relative to prices by competitors, resulting in empty seats and cancellation of flights, which ultimately affects the airline’s competitiveness, wrote Stella Mutuku and Simeon Tunje who are economists at the Kenya Institute of Public Policy, Research and Analysis (KIPPRA), a quasi-government think-tank.
“The key challenges for KQ include but not limited to high operating costs, inefficient fuel hedging strategies, inadequate corporate leadership and governance. It is therefore evident that beyond the nationalization strategy, corporate leadership, robust network, and infrastructure, price leadership are the fundamental strategies that would expand KQ footprint, establish Nairobi as the aviation hub of Africa, and yield the bigger economic gains of air transport.
“Reinforcing the leadership and governance structures of the national carrier will greatly improve the bottom line, hence mitigate losses. In addition, it is expected that the reviewed booking policy and guidelines will address the challenges facing KQs expensive ticket prices and enhance firm competitiveness,” they argued.
But some independent analysts reckon the future is still bleak for KQ even with the bailout plan.
“There is no evidence that the State’s plan would help improve the company’s business fundamentals. In a capitalist system, the market must be allowed to discipline individuals or firms that make bad business decisions,” said George Bodo, an analyst who heads the financial desk at Ecobank Capital.
“I can’t help but feel for minority shareholders. KQ balance sheet restructure in 2017 messed up minority shareholders. In the restructure, the company asked all its major creditors to swap debt for part ownership in a rather intricate transaction. The net result of the transaction was that minority shareholders were squeezed out” he added in a recent column in one of the local dailies.
In 2017, Kenya Airways had embarked on a turnaround strategy dubbed ‘Operation Pride’. Corporate governance at the national carrier was also bolstered by the appointment of Michael Joseph as its Board Chairman. At that point, the share was doing quite well at the bourse. However, recurrent industrial action by its pilots drawn from umbrella body, KALPA, has provided serious headwinds. In 2010, it had rolled out a 10-year strategy “Project Mawingu”, a project that would essentially trigger more turbulence.
The project sought to grow sizeable freighter aircraft fleet expansion from 31 aircraft in 2010 to 120 aircraft by 2020 and destinations from 58 to 115 routes in 77 countries in six continents by 2021 and expand its routes to Asia. The profitability turbulence in 2015, recording a Sh26.2 billion loss, resulted in a halt of “Project Mawingu”, including a retiring of two Boeing B737-300 aircrafts.
The airline had hoped to reap the benefits from its turnaround strategy, which was marked by fleet rationalization as a cost containment measure and sale of its fixed assets, which was to boost its cash position.
“When KQ was privatised several years ago, we wanted to insulate it from the suffocating grip of State control. Where is the assurance that nationalisation will not spawn a regime of political interference, like in appointment of CEOs? Have we figured out the likely impact of thrusting the national carrier into the stifling procurement regime, within which all government-owned companies must operate?” wrote Jaindi Kisero, a columnist with the Daily Nation in a recent commentary.
“First, it is an open secret that the Government has cash flow problems. Secondly, the project does not appear to have a strong champion to drive the fundamental changes through key decision-making centres of the state apparatus. The state of politics in the Jubilee administration is another factor. With political power within the regime becoming more and more diffused, the appetite for implementing bold decisions as contemplated in the plan has more or less dimmed” he added.
In June 2017, the national Treasury brokered a deal to save KQ in what saw 11 Kenyan banks agree to convert Sh23b Kenya Airways loans into shares to get the struggling airline working capital. The banks, which included Equity, KCB Group, Commercial Bank of Africa and Co-operative Bank, formed a special purpose company through which they own shares in the carrier. The others are Jamii Bora, I&M Bank, NIC Bank and Ecobank, Chase Bank (sold to SMB), National Bank (bought out by KCB) and Diamond Trust Bank.
In 2018, the banks advanced KQ additional loans amounting to Sh4.3b as part of the capital restructuring at the airline. The new debt was backed by government guarantees, protecting the lenders from the national carrier’s default. By that time, it was reported that the airline, defaulted on the lenders’ initial facilities of Sh16.7b ($165.3m) and instead issued them with shares amounting to a 38.1% stake as a compromise settlement.
Fast forward. On July 6, Kenya Airways said it would get rid of some assets, reduce its network and lay off an unspecified number of workers to limit losses from Covid-19. By the time of going to press the airline had began sending employees home in earnest, especially targeting clerks, groud operators, accountants, cabin crew, inflight functions and cargo operations most of whom had been hired early in the year and were still serving on probation. Insider sources intimate the airline targets to offload at least 600 employees.
KQ has been operating in a highly competitive environment and has reported a declining dominance in the African skies while the competitors in the region, particularly Ethiopian Airlines and Gulf Airlines are growing their footprint. Ethiopian Airline has over the years reported a gradual growth, with a fleet of over 100 aircrafts while KQ flies half the fleet.
How does the future look like for KQ?
The International Air Transport Association (IATA) has renewed its call for government relief measures on airlines as the impacts of the COVID-19 crisis in Africa deepen.
IATA projects that Africa’s airlines could lose $6b of passenger revenue compared to 2019. That is $2billion more than was expected in March. In Kenya specifically, IATA projects 3.5 million fewer passengers resulting in a $0.73b revenue loss, risking 193,300 jobs and $1.6b in contribution to Kenya’s economy.
Job losses in aviation and related industries could grow to 3.1 million, which is half of the region’s 6.2 million aviation-related employment. Previous estimate was 2 million. According to IATA, the full-year 2020 traffic is expected to plummet by 51% compared to 2019. The previous estimate was a fall of 32%.
“In the wake of COVID-19, we have continued to contribute to sustaining the lives of communities in Africa by providing the connections for our produce to reach international markets, medical supplies to reach our people, and families to be reunited,” said KQ CEO in a public statement.
Mid July, KQ said it would drop direct flights to the United States and China in its international flights from August. The airline said it had halved its routes to 27 and cut the frequency of flights to some destinations with passenger demand expected to remain depressed for at least 18 months.
“The crisis has significantly affected economies around the world and the aviation sector in particular. We estimate that it will take at least a year to gain the confidence of the travellers and start recovering the travel demand,” said Mr Joseph.
It is estimated that KQ lost an estimated Sh10.6b in revenues in the six months to June, following the Covid-19 pandemic.
“The airline industry faces its gravest crisis. Within a matter of a few weeks, our previous worst-case scenario is looking better than our latest estimates. But without immediate government relief measures, there will not be an industry left standing. Airlines need $200b in liquidity support simply to make it through. Some governments have already stepped forward, but many more need to follow suit,” said IATA director-general and CEO Alexandre de Juniac.
Only time will tell where KQ will fly next.