Kenya Airways – turbulent times and trouble in the skies

KQ Plane

NAIROBI – Kenya Airways, the Kenyan National Carrier and once acclaimed most profitable airline in the continent and winner of the ‘Most Respected Company in East Africa’ has been facing perhaps the strongest headwinds since its privatization in 1995.

From lower tourist numbers in Kenya due to insecurity fears, disruptions of operations in West Africa due to Ebola pandemic, volatility of fuel prices, rapid expansion causing liquidity constraints, stiff competition from rising cheaper airlines and new entrants to the Kenya – overseas routes, the airline’s executive team are facing a trying time as they attempt to steer the airline past this turbulent time.

The current CEO – Mbuvi Ngunze took over what was a giant in the skies from retired Executive Titus Naikuni, and since then perhaps he has been drowning in a fit of blows thrown his way by systematic changes typical of the airline industry.

Operational Constraints and Lower Bookings

2014 will perhaps be remembered in Kenya’s Capital Markets as the first year when a company declared a Sh10.45Bn Loss – Kenya Airways (or KQ as it is more commonly called) for that matter. It will also be remembered as the year when the World was shaken by perhaps the worst Ebola break out in history.

For Kenyans, the death toll and loss of property due to attacks by Al-Shabaab was also highest in 2014, a situation that caused a ripple of travel advisories issued by Kenya’s tourist hinterlands in Europe, United States and resulted in a slump in the tourist sector.

Tourism earnings fell 7.3 per cent to Sh87.1 billion in 2014, down from Sh94 billion the previous year as a spate of insecurity and travel advisories issued by key source markets continued to bite.

International visitor arrivals dropped to 1.35 million last year from 1.52 million in 2013 and 1.82 in 2011, affected this year by a string of deadly attacks on Kenya’s Indian Ocean coast and elsewhere, which were blamed on Islamist militants and prompted some Western countries to warn against travel to the country. This has seen thousands lose jobs and more than 40 top hotels close shop due to the low bed occupancy.

The airline estimated that it lost at least four per cent of its annual revenues due to disruption of flights to West Africa as the deadly hemorrhagic fever continued its rampage in Liberia, Sierra Leone and Guinea. The loss in money terms was estimated at Sh4Bn.

KQ’s flight into the Ebola headwinds comes at a time when the company is grappling with reduced tourist arrivals in the wake of security concerns and rising operational expenses such as wages, fuel and financing costs. Attacks at the Coast and Nairobi in 2014 by the terrorist group Al-Shabaab also dampened bookings, especially on the popular London-Mombasa route, by approximately 40 per cent following travel advisories by several Western countries.

Liquidity Problems and the Heavy Weight of Debt

The period 2002 – 2011 witnessed the fastest growth in Kenya’s Economy as key economic sectors picked up the slack from years of mismanagement, and at the same time many Corporates took advantage of the conducive business environment to improve their fortunes.

During this period, tourist numbers almost quadrupled and from 2002 to 2011, KQ grew from a turnover of Sh25 billion to over Sh100bn in the same period, successfully listing rights issue and began the process of revamping its fleet. Just as any other airline, there was need to incorporate newer and efficient airplanes to its fleet hence KQ’s fleet expansion that resulted in heavy balance sheet loads.

As at September 2014, KQ had total current liabilities worth Sh70 billion, of which Sh40.7 billion are short- term loans, Sh16 billion is owed to suppliers and Sh11.4 billion is cash due in advance of carriage (pre-payments).

On the other hand, long-term loans stand at Sh95 billion or 94 per cent of the total non-current liabilities. The financing costs related to these liabilities prompted KQ to hire a consultant to advise on ways of restructuring these, as well as a return to profitability strategy in October 2014.

The liquidity issues came into the fire during a TV interview when the CEO admitted that the mismatch between current liabilities and cash generated from Operations had forced KQ to prioritize its payables, causing a delay in payment of salaries as the airline turned to more short term debt to bridge the gap.

KQ also made a quick-turn on its expansion strategy as it had lined up purchase of several  Dreamliners to add to its modern fleet, but in April 2015, the cash-strapped airline struck an agreement with leading aircraft leasing firm AWAS to acquire the planes from Boeing and lease them to the Nairobi-based airline.

Dublin-based AWAS announced that it has agreed to a purchase and leaseback transaction for three Dreamliners, the first of which was delivered in April.

On its short term routes, via its low cost JamboJet airline, KQ leased further planes and crew from DAC Aviation, signaling a change of strategy from owning the planes to leasing them from renown players – one that has little cash injection at inception and ensures maintenance costs are well monitored and in some cases, incurred by the Lessor.

Competition amid rising costs

The steady rise and coverage of other airlines in key destinations across Africa (that were previously KQ’s strong point) has sparked gruesome competition, which puts into perspective the impact of managing costs in a competitive environment for KQ.

Partnerships between the airlines enables each airline to enjoy mutual growth from connecting passengers and cargo transport from key destinations and inward into the destination country’s destinations, according to each airline’s strength and competitive advantage. This is done through codeshare agreements.

The biggest advantage that Asian and Gulf airline companies have over their African counterparts is their ability to minimize costs via cheaper labour, proximity to fuel sources, and higher volumes due to international trade.

The rise and rise of cheaper airlines as they venture deeper into Africa like Turkish Airlines, Emirates, Gulf e.t.c. posed perhaps the greatest threat to KQ’s inefficient model and as penetration to KQ dominant destinations increased, the stage was set for perhaps a fight of the titans against the minnows.

Ethiopian Airlines rise and its acquisition of a 48% stake in Air Malawi in 2013 allowed the regional airline to set up its third base in South Africa. The presence of Ethiopian Airlines — which is bigger and so far one of the most successful carriers on the continent effectively ensured that KQ’s African presence was under threat and the competition would effectively favor the cheaper and cost-effective carrier.

Kenya Airways also emerged as a big loser with the launch of China Southern Airlines’ direct flights from Nairobi to Guangzhou. The national carrier had a code sharing agreement with China Southern Airlines, which allowed it to fly passengers to Guangzhou after which it would transfer them to the Chinese airline for domestic connections.

The launch of China Southern Airlines flights to Nairobi, however, means that the national carrier will lose out on passenger referrals that it was getting as travellers who wish to connect to other Chinese cities from Guangzhou will now prefer to use the Asian carrier.

Apart from the code share agreement Kenya Airways has been enjoying, the new entrant poses a commercial threat to the national carrier which introduced direct flights to Guangzhou in 2013.

The cost-effective models, and wider range of destinations offered by European, American and Asian airlines which now cover almost all of Africa in a bid to boost International trade with Africa, further pose the most significant threat to KQ as it rethinks its expansion strategy and as it seeks to increase volumes seeking to cover its growing operational and financial costs.

Moving forward

It remains to be seen how the National carrier will survive the turbulent times it is facing. The state of insecurity in Kenya continues to dampen tourism fortunes, though the ban due to Ebola in Liberia has been lifted as the country was declared Ebola-free in May 2015.

It is not all bleak however, as Jambojet, KQ’s local low cost carrier seems to be boosting local tourism which seems to be improving. Cargo volumes are also expected to increase in 2015 as weather conditions favor increased horticulture output that is mainly exported to Europe.

The EAC integration may see Jambojet increase its regional destinations, which is expected to further boost KQ’s topline though the results of the integration will only reflect in the medium to long term, owing to the integrations’ slowdown due to numerous red-tape barriers.