Strike pushes KQ into a headwind

The settlement of a trade dispute between Kenya Airways and its workers is expected to give management breathing space as the airline battles with a host of internal challenges and external threats over the next two years.

Officials at KQ estimate that the strike cost the airline between Sh150 million and Sh200 million per day over the two and half days it lasted meaning at least Sh375 million may have been lost.

But the big question in investors’ minds is whether the airline will really be able to turn the corner in the next two years, after reporting Sh5.66 billion losses in 2009.

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 of Sh25.

Like most cyclical stocks, Kenya Airways 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.

Last week’s events offer surprising insights into how the airline’s aggressive expansion over the last five years has systematically yielded to the management and operational challenges that culminated in the labour strike. This serves to remind investors of both how lucky KQ has been with its workers and how vulnerable it can be to poor labour relations.

Airlines the world over have been facing deteriorating labour relations as they struggle to cut costs in the face of the global recession.

Since August last year, KQ’s management seems to have been lurching from one labour crisis to the next. First it was the engineers in August, then pilots in November and now the recent strike by some cabin crews and assorted range of ground workers.

Though Sunday’s settlement which will give workers a 20 per cent pay increase staggered over two years will buy time for management to address relations, it is not cheap as it will add nearly Sh1 billion to the airline’s wage bill in two years.

Assuming the airline will continue growing at its historical pace and operating costs do not change much, creeping labour costs might depress its operating margins by nearly one per cent at a time when financial markets are still volatile and KQ’s debt levels are rising.

This means after accounting for currency fluctuations and payments to banks, investors will be getting much less from every shilling of revenue generated.

Over the last five years, the airline’s ability to make money has reduced significantly as it expanded. In 2004, with revenues at Sh40 billion, it would make 16 cents for every shilling generated; last year, this had fallen to 5.75 cents with sales at Sh70 billion.

Hard times
However, at a deeper level, when the business is examined from a pure operations standpoint when the effects of capital structure (debt) and the huge costs of renting aircraft and engines are taken into account, KQ has maintained its earnings power over the last five years.

This phenomenon is captured by a metric used to value airlines and compare them known as EBITDAR (earning before interest tax depreciation, amortisation and rent) which shows that KQ delivered an EBITDAR of Sh13 billion in 2008, compared to Sh14.4 billion three years earlier.

When this performance is evaluated from a traditional accounting perspective of looking at operational profits, the business seems to be doing significantly badly, which is misleading.