Kenya Airways flies into stormy skies as costs rise

Kenya Airways is headed for harder times as it tries to navigate the skies during the tough economic times that have left many players in the aviation industry fighting for survival.

The airline is grappling with increased costs due to rising prices of fuel, rising overheads and fleet ownership costs, among other issues.

Although it is generating cash, it is not enough to sustain it.

In addition, the slowdown in the global travel industry has hit the airline’s passenger and cargo numbers, reducing operating profits by eight per cent to Sh162 million in the first half of this financial year, ending September 2009.

Fuel cost instability and revenue management are among the top challenges for carriers across the world over the next 18 months.

Kenya Airways chief executive Titus Naikuni is now weighing his options, including job cuts, to save every shilling that he can and to increase revenues.

“I am not ruling out job cuts, I’m not ruling out anything, although we also have to work efficiently to cut costs,” he said in a recent interview with Business Daily.

Job cuts have become a common feature in the aviation sector as airlines look at ways of cutting costs. British Airways recently said it would cut 2,000 cabin crew jobs—a move that has met major resistance.

In the past two years, Kenya Airways has invested heavily in its systems to improve business efficiency, including cargo and baggage handling to curb delays.

Such delays costs the airline dearly as it has to compensate passengers.

Global economy

KQs share price has fallen by over 80 per cent in the last three years, from a high of Sh116 to the current price of Sh24.75.

According to Mr Tony Waweru of Standard Investment, the share has been stable for a while, drawing more interest .

Like most cyclical stocks, KQ would be expected to benefit from a recovering global economy but the months ahead look even more challenging due to factors that the management can control and some beyond reach.

Mr Justus Agoti, an analyst at Sterling Securities, is positive that the second half is likely to be better than the same period last year as the global economy is showing signs of recovery and fuel prices are moving up.

“There will be an improvement in the bottom line though not high in the second half,” he said.

In the first six months, the airline saw its overheads increase to over one billion shillings due to the payment of Sh618 million to union workers following a two- and- a -half day strike.

The airline and union agreed on a 20 per cent salary increment to be paid out in two years.

The balance was additional costs in support of the realised growth in capacity, recruitment and training costs to support growth.

KQ increased its capacity, contrary to industry trends; most airlines have reduced capacity due to the slow demand.

The global industry’s capacity, measured as Available Seat Kilometres (ASK), is down 3.6 per cent while KQ’s stands at 6.7 per cent.

The airline says this was to support its African network where it launched six new routes during the period, mainly in central and southern Africa.

But traffic remained low on some of the routes, meaning that the airline was not able to cover all its costs of flying its equipment.

The airline’s actual passenger traffic, which is measured in Revenue Passenger Kilometres (RPKs) dropped by 4.7 per cent.

This led to the Cabin Factor, which shows use of available seats drop to 66 per cent from 73 per cent from the previous period.

The airline also saw both passenger and cargo yields drop due to competition in the market , leading to lower prices which subsequently eroded its yields.

The national carrier earned less in US cent, the industry measure, but more in shillings mainly due to the weaker currency.

Despite the reduced revenues and operating profits, the airline posted a 17 per cent increase in pre-tax profits to Sh1.2 billion for the period ending September, 2009.

This was from gains of acquiring un-hedged fuel at market prices, which were lower compared to the prior period, leading to a direct saving of Sh5.7 billion.

As some hedges expired, the airline was able to get new ones at a cheaper price.

For the year ending March, 2009, the airline announced a loss of Sh5.6 billion mainly driven by new accounting standards that saw it book Sh7.5 billion in its financial statement from unrealised hedging positions.

A lifeline

The airline hedged between $108 and $110. But the upward movement of fuel in the past few months has given the airline a lifeline as it could see a return to profitability earlier than expected.

The losses from the hedges have not deterred the airline from hedging its fuel up, a common practice in the aviation sector.

Mr Naikuni says despite the losses, KQ would still continue hedging as this has saved it millions of shillings in the past.

“We are reviewing our hedging policy, are not scared of it and we will make appropriate decision as and when we see it is the right time. We look at the long term effect,” he said.

KQ has 53 per cent of its fuel hedged until the end of the year and 33 per cent until the end of 2010.

Once fuel prices reach highs of $100 per barrel the airline will be in the same situation that was witnessed in 2007 and early 2008 when high fuel prices led to the collapse of some airlines globally.

In order to cushion itself, the industry increased fuel surcharges, leading to passengers paying more on fares.

For KQ, only time— and what the competition does— will tell, for it is in a precarious situation of trying to attract passengers in a slow travel market and cushion itself from increased costs.