Kenya Airways future pegged on fuel pricing

Kenya Airways moved back to profitability in the first half ended September driven by gains from fuel contracts despite sluggish performance of its core business.

Analysts reckoned that the airline’s performance in the current financial year is largely dependent on the direction the petroleum prices in the second half since the firm is forecasting a low demand for travel and cargo services.

The national carrier posted a 17 percent rise in pretax profit to Sh1.23 billion, despite significant pressure on its passenger numbers and cargo volumes.

The reduced activity in these core businesses is underlined by the eight per cent drop in operating profit, pulled down by a 1.7 per cent drop in revenues to Sh33.4 billion.

The profits were mainly driven by the Sh1.72 billion gain on fuel hedging contracts which was a 20 per cent increase compared to the Sh1.43 billion it earned in a similar period a year earlier.

The gain was attributed to the current fuel prices that were trading at above most of hedged contracts that the firm signed in the first half of this year, after the expiry of some expensive hedging contracts.

Now, the firm is expected to maintain the same profit trend if oil prices remain at the current level, since it will be gaining on most of the hedged contracts.

But its investors looked unimpressed as the share remained unchanged at Sh24.50 on Friday despite improved performance. KQ’s share price has fallen by over 80 per cent in the last three years from a high of Sh130 to the current price.

In the second half of last year, the airline booked a Sh7.5 billion loss it incurred from unrealised hedging position in its income statement, taking it deep into the loss-making territory.

At the time, it had hedged 56 per cent of its fuel hedged between $108 and $110, the global financial crisis brought petroleum prices down tumbling and left the national carrier with huge losses from the deep hedging position it had taken in the jet fuel market.

Currently, the airline has hedged 53 per cent of its fuel under, with most hedged held at below current prevailing jet prices.

This means it would continue gaining on the hedged contracts unless fuel prices falls significantly, which is unlikely as oil prices are expected to surge on optimism over the global economic recovery.

“Going ahead the volatile fuel prices will continue being a challenge,” said Bram Steller, the airline’s chief operating officer.

Lower fuel prices, compared to the same period last year, saw the airline record a direct saving of Sh5.7 billion on its un-hedged fuel, the airline’s chief operating officer.

Statistics from IATA, an industry lobby, shows that jet fuel is currently trading at $84.8 per barrel, a 5.9 drop compared to a year ago, meaning that KQ is still making gains on un-hedged fuel.

But with demand for fuel expected to rise on the recovery of the global economy, the airline might not make savings in its un-hedged fuel bill in the second half of this year compared to the first half.

Despite the gain from fuel the airline recorded a slight decrease in its revenue to Sh33.4 billion from Sh34 billion same period last year.

The 1.7 per cent was due to a drop in cargo though passenger and handling revenues increased.

Cargo revenue dropped to 2.5 billion, a 15.9 per cent drop, with only 26,339 tonnes being uplifted during the period.

The current low passenger numbers are expected to hold into the second quarter as travellers stung by the global economic meltdown keep off the skies.

All routes experienced a drop in cargo uplifts with East Africa recording the highest drop of 44.7 per cent.

The drop in cargo numbers is in line with global industry figures that tumbled towards the end of last year.

Passenger numbers dropped by 1.9 per cent to 1,421,000 during the period due to traffic reduction in Asia, the Middle East and Europe.

Africa and the domestic market recorded positive growth in the first six months.

In a bid to continue recording positive growth from its strong markets the airline has put more emphasis on its cash cow region, Africa.

The airline is not relenting on its expansion in the region.

In the first seven months of this financial year the airline has introduced six new routes in the region, with focus on southern and central Africa.

It is now focused on adding three new routes on its network mainly to Saudi Arabia, Democratic Republic of Congo and Sudan.

It is also looking at increasing its frequencies on some of its high potential routes most of which are in Africa.

“We are putting strong emphasis on growing our routes. This is our life line to increase revenues,” said Mr Steller, adding that the European routes are expected to remain sluggish.

However, the expansion has been sucking all its free cashflows — the cash profits that can be distributed to shareholder— as the management invests into the future. KQ’s costs have been going up since 2005.

In this period overheads increased by Sh1.1 billion to Sh6.8 billion, a 19 per cent move, mainly driven by a new agreement reached by union staff and the management mid this year.

Expansion plans

In August 2009, union staff in the airline downed their tools demanding salary increment.

The management reached an agreement with the Aviation Allied Workers Union (AAWU) after two and a half days of the strike.

The 20 per cent increment was reached, to be staggered to two years, saw the airline pay out Sh618 million on back dated salaries.

In addition, the airline incurred costs of accommodating passengers as well as immeasurable costs like on reputation and lost clients.

“Cash is king in our business. We have to increase revenues and reduce costs in order to improve our cash,” Mr Alex Mbugua, the airline’s financial director told investor.

KQ is also faced with challenge of the continued delay of the Boeing 787, by the manufacturer.

These planes, which were expected in 2010, have been delayed by three years and were part of the airline’s expansion plans to new markets and to increase frequencies.

“The Dreamliner was meant to be a big dream but it is turning to be a nightmare,” Mr Mbugua said.

The airline is re-looking at either extending the ageing Boeing 767 leases, acquire new vintage B767s or acquire new Airbus 330.