Kenya Airways is running out of options to extricate itself from a financial crisis that has seen it struggle to settle financial obligations to employees and creditors.
The airline has turned to short-term loan facilities to pay employees in the face of huge equipment debts and a deteriorating business environment that saw it issue a profit warning for the year ended March 2015.
Chief executive Mbuvi Ngunze said that salaries for the airline’s nearly 4,000 workforce were being paid through bank overdrafts because of liquidity pressures arising from falling passenger numbers and long term commitments to lenders estimated at $800 million.
“We are currently looking for an option of restructuring our debt burden as a first step in turning around from our loss position. Measures have been put in place to rationalise costs, including the option to hire some of the support services through third parties and retire staff,” Mr Ngunze said.
KQ was in the news last week for delaying the remitting of loan deductions from some of its employees to various banks. Last November, the airline announced a plan to initiate the process of refinancing the company’s balance sheet.
It is understood that a transaction advisor is being sought on the restructuring with a sizeable bond issue one of the options. Whether it will get investors on board with the financial turbulence on its flight path remains to be seen. Some market watchers say it could take as many as three years for the carrier to balance its books.
“This month, March, the remittances based on deductions from staff were delayed. This one-off occurrence was notified to the staff and banks. The airline continues to endeavour to meet its liabilities as they fall due and to reduce them in line with business needs,” Mr Ngunze said.
The airline’s short term loans stand at $456 million while the outstanding debts to suppliers are at $178 million. It also has cash due in advance of carriage standing at $122 million.
“We are going through a refinancing period so as to rebalance our debt structure from short term and medium term. We are also looking at a long term bond that could be combined with some injections,” Mr Ngunze said on an evening television show.
Daniel Kuyoh, a research analyst at Kingdom Securities said that bond financing isn’t a viable option for KQ especially because of its urgent need to reduce its debt obligation.
“The way out should be a significant capital injection by its two major shareholders, the government and strategic partner KLM. The airline’s debt levels are toxic and increasing its debt position would not be advisable. They need to be recapitalised, take re-evaluation loss and build an equity position from the cash generated,” Mr Kuyoh said.
KQ books show that it has been borrowing significantly to cover the cost of a fleet renewal started in 2013. Six B787-8 Dreamliners have so far been delivered as well as four B777-300s.
The carrier had hoped the fleet renewal would enhance the customer experience and save the airline costs because of the fuel efficiency of the wide-bodied aircraft.
A practical challenge has however arisen with the bigger aircraft: With depressed passenger numbers it is cheaper to ground the planes rather than fly them half empty.
“The debt to equity ratio of Kenya Airways has reached the point where it is unsustainable for its cash flows to cover the liabilities and grow shareholder equity, a key metric for a listed business,” Mr Kuyoh said.
John Kirimi, executive director at Sterling Capital, said that KQ should renegotiate some of its financing options to fairly soft terms.
“The airline should go for capital restructuring so as to enable it to restructure the borrowing period, hence reduce the repayment period. It can also go for cheaper loans to repay the expensive loans so as to reduce the financing charges,” Mr Kirimi said.
The airline operates in a high-cost, low-margin industry, with staff costs usually being determined by negotiations with unions rather than performance. The airline has recently been hit by industrial action involving pilots, ground and cabin crew.
In its half year results to September 2014, operating costs stood at $799.4 million with fuel cost accounting for 38 per cent of the overheads. Maintenance and staff were the other major costs. Finance costs increased to $25.4 million up from $20.1 million in 2013.
The costs are expected to increase following the delivery of more aircraft last year. The airline has had a bad record with hedging, especially with the wild swings in jet fuel prices.
“It’s important that the airline has retired some of its fuel inefficient planes as this will go a long way to mitigate its fuel costs component. With the current oil prices, KQ is in line to benefit from fuel cost savings and probably pocket considerable returns in fuel hedging,” said Genghis Capital analyst Florence Kimaiyo.
The airline retired its entire B767-300 fleet in November 2014 and replaced them with Embraers, which are deemed less expensive to operate in terms of fuel, maintenance costs and frequency schedules.
“The board allows us to hedge up to 80 per cent of our fuel over a year. Today, we have a more expensive fuel price because of the last fuel price drop and the hedged contracts. However, we expect this to come lower because we have several short term hedge contracts that vary between two and six months. We have reduced the level of our hedge book because as the hedges expire, it now allows us to take advantage of the price drop so that we can enjoy lower fuel costs,” Mr Ngunze said.
Mr Kirimi, however, said KQ should renegotiate some of the longer term hedges in order to get a substantial boost on operating costs.
At the same time, Middle East carriers have put pressure on KQ on its key regional and international routes — some of them helped by direct subsidies or fuel cost benefits.
Flydubai, Emirates, Etihad and Qatar Airways have all increased their touch points in Africa. Emirates plans to deploy a larger Boeing 777-300 ER on the Nairobi route from next month. The route was previously served by an Airbus A330-200.
External competition aside, the negative cash flows of the past three to four financial years have eroded KQ shareholder value to a point where the share price is below the initial public offering price of Ksh11.25 in 1996, without taking into account inflation, bonuses and share split, to trade at Ksh8 each.