Regional carrier Kenya Airways (KQ) plans to build a five-star Hotel in Nairobi as it moves to bolster its revenues after its net profit for the year ending March 31, 2012 fell 50 per cent, the airline said on Thursday.

While releasing the results, the airline, which is owned 26.73 per cent by Air France KLM and 29.8 per cent by the Kenyan government announced a cost-cutting plan as it seeks to manage expenses which pushed profits down to Ksh1.6 billion ($19.5 million) from last year’s Ksh3.5 billion ($41.7 million).

Titus Naikuni, KQ’s chief executive officer said direct costs rose 44 per cent from Ksh53 billion ($624 million) in 2011 to Ksh77 billion ($906 million) in 2012, while net profit margins fell from 4.1 per cent in 2011 to 1.5 per cent in 2012.

The airline had earlier in the year issued a profit warning, citing high fuel costs. Fuel costs accounted for 53 per cent of the direct costs up from 46 per cent in the previous year following a 29 per cent upswing in fuel prices in the period.

“The volatile fuel costs will act to maintain uncertainty in KQ earnings and for the industry at large. Though hedging may offer reprieve, the increase in direct costs will sustain pressure on margins” said analysts at Sterling Capital in an investor note.

“Insecurity in the country and the Euro zone woes are expected to weigh on the passenger numbers. Given the expectation of persistence in underlying factors including fuel and forex rates, it is unlikely that a significant reversal in fortunes will be forthcoming in the near term” said Sterling.

(Read: Will Kenya Airways get it right this time on low-cost carrier?)

Precision Air, KQ’s associate business in Tanzania, delivered KSh238 million ($2.8 million) in share of associate income, and another Ksh251 million ($2.9 million) in gains on deemed disposal (with KQ’s shareholding having reducing following a rights issue undertaken by the Tanzanian associate).

The news come only days after the airline announced it has raised Ksh14 billion ($165million), against a target of Ksh21 billion ($247million) in its recently concluded rights issue at the Nairobi Securities Exchange (NSE) where it is listed.

Having raised less than the desired amount of funding desired in the rights issue, KQ is considering scaling back its expansion in combination with taking additional debt. Mr Naikuni said turnover rose 26 per cent to Ksh107 billion ($1.25 billion) from Ksh86 billion ($1 billion) the previous year.

The move to build a hotel will help the airline to minimise accommodation costs for transit or delayed passengers, its executives said , which cost it Ksh450 million ($5.29 million) last year. “The main drivers for improved performance are passenger numbers, better yields and more stringent cost management,” said Evans Mwaniki, KQ’s board chairman.

The rise in direct costs was driven by a 29 per cent rise in oil prices during the year, which saw the pushed the oil component from 46 per cent of total direct cost in 2011, to 53 per cent in 2012.

The wage bill rose by 33 per cent, driven by a salary review for unionised employees and the new hires during the financial year.

Analysts at Sterling Securities say given that most of KQ’s major cost are beyond its control, the airline could be facing a challenging period in the near future.

“Given the expectation of persistence in underlying factors including fuel and forex rates, it is unlikely that a significant reversal in fortunes will be forthcoming in the near term,” Sterling Securities said in a research note to investors shortly after KQ announced its full year results.

The airline is said to be keen on borrowing funds to bridge the shortfall in its rights issue, as it requires the money to make pre-delivery payments aircrafts it plans to acquire.

Airlines manufacturers normally demand at least 20 per cent of the value of a plane order be paid at least 2 years before delivery. Kenya Airways are to pay $250million in pre-delivery orders for planes it expects to receive in the next two years.

The airline is banking on the cash to fund an ambitious expansion strategy that will see it fly to all African capitals by 2013, as well as double its current fleet of 31 planes by 2015.

KQ is battling increased competition especially from Middle East carriers such as Etihad Airways, Emirates, Qatar Airways, Etihad and Turkish, which are opening up more routes on the continent where the Kenyan carrier draws nearly half revenues. Ethiopian Airlines, KQ’s major rival plans to increase its fleet of 47 planes by ordering an additional 35 aircraft in the next 15 years.

To beat the rivals and keep revenues on a linear growth path, KQ has placed orders for 10, 96-seater Embraer planes, slated for delivery in 2013.

The company has the option of exercising the right to buy 16 other planes. The airline has also placed an order for nine Dreamliners. These fleet expansion plans, are part of the five-year plan to double its fleet, from the current 31.

Kenya Airways, the third largest airline in sub-Saharan Africa in terms by both passenger and aircraft fleet size, is banking on the delivery of these new aircrafts to help rein in fuel costs and boost efficiency. The Dreamliner for example, uses 20 per cent less fuel compared to the Boeing 747.

(Read: Why flying in Africa is a turbulent business)

“The KQ fleet is younger than the global average and the African average, however, there are still a number of 767 aircrafts in the fleet, performing key services whose age means maintenance costs will be high and fuel efficiency lower.

The new orders of Embraer 190’s and Boeing 787s are aimed at addressing these efficiency issues,” the company said in its rights issue memorandum.

But it’s not just the big brands offering competition, regional brands in the name of Fly540, Jetlink, Precision Air, Rwanda Air, and Uganda Airways continue to pose a strong challenge to KQ.

This increased competition from these players seem to have informed KQ’s decision to form a low cost Jambo Jet, the subsidiary that it hopes will be able to offer these regional carrier competition especially in terms of pricing.