Endau Analytics

Airbus and AirAsia X, a match made in heaven?

3-9M-XXT-2019-07-04-01Cr-AirAsiaX-A333-XintillatingPhoenix-TOS-KUL copy 2

Dubbed the Xcintillating PhoeniX, an AirAsia X Airbus A330-300 is seen here at klia2 in Sepang. Pic/KCSim

The two questions we wanted to ask the Airbus CEO during the plane maker’s 2021 annual results briefing Q&A on 18 February were simple ones.

If AirAsia X, Malaysia’s low-cost, long-haul airline cannot be revived, would it spell the end of Airbus’ A330neo programme? And did he agree with Tony Fernandes that the AirAsia Group and Airbus “love each other” and that they were both “joined at the hip”? 

Ensconced comfortably in his seat in Toulouse, Guillaume Faury could not say yes or no.

In fact, he never had a chance to address the query because the moderator – more likely his minders – rejected our request to probe him. Twice.

It is entirely the prerogative of Airbus to select who it felt should have the privilege of interrogating its CEO.

However, for a company that has invested over USD400 million in Malaysia and more across Asia Pacific – supposedly its “core market” accounting for over a third of total orders to date – it was odd there was not a single, specific question (out of nearly 20) on the region during the session.

Why bother inviting people from Asia if you did not want to hear from them?

The following are just some of Airbus’ customers in Asia Pacific.

AirAsia Group is Airbus’ biggest customer for the A320 family. The airline has ordered over 660 in the past 15 years. AirAsia X currently operates 36 A330-300ceos and has ordered 78 A330-300neos, 10 A350-900s and 30 A321XLRs.

India’s IndiGo has a firm order for 300 A320neos and took delivery of 44 of the aircraft in 2020 alone. If the A321 and A321XLR are included, the carrier will have a total of about 730 Airbus jets.

Indonesia’s Lion Group runs a fleet of 44 A320s under its Batik Air badge with 190 orders still unfilled. On 18 March 2013 Lion placed an order for 234 A320 aircraft. Its Thai Lion Air unit flies the region’s first A330-900 while six A330-300ceos are with the mainline carrier.

In Vietnam, VietJet has 73 A320 family of jets in service, with 20 A321XLR on order (including five to be converted from the A321neo variant). And VietJet has a training facility agreement with Airbus comprising two A320 simulators. 

You get the drift.

The Q&A lasted for about an hour following updates by Faury and Dominik Asam, Airbus’ CFO.

There was just the one token question on Asia, specifically on China (which is not reflective of the region) and a different beast (this year, an Ox) altogether.

Somebody asked if the emergence of China’s C919 plane posed a threat to the duopoly of Airbus and Boeing.

Faury is an engineer by training and so by definition, dedicated to precision. As chief of a European company with a huge Final Assembly Line in Tianjin, in the world’s largest and most important market, he is also the consummate diplomat.

He commented: “It’s too early to say to what degree Comac (the maker of the C919) will be able to compete with Boeing and Airbus,” and added, for good measure, “but we are taking them seriously and we are watching carefully what’s happening there.”

A technically accurate reply, most definitely. Woefully inadequate, too.

The reporter had asked a question that Faury knew could only be incited with a politically correct answer.

Indeed, the whole proceeding was a strain, like watching one of those Euro-centric movies that does not make sense, because it is not supposed to make sense.

Airbus Results 2021

I’m not taking your question today… Airbus CEO Guillaume Faury during the company’s results briefing on 18 Feb 2021.

The X-rated carrier 

As the coronavirus continues to create mayhem, the pained speculation, the postulation and guess-work begin as we try to figure out and understand how Airbus plans to restore health to its acutely ill twin brother.

We know the opinion of one leasing company that is owed money by the cash-strapped airline, describing the carrier as “hopelessly insolvent.”

Should an impecunious airline with debts and liabilities of close to USD16 billion and barely making ends meet since its IPO in 2013 be saved?

To put things into perspective, AirAsia X was listed on the Kuala Lumpur bourse at an offer price of MYR1.25. At the close of market on 23 February 2021 a share was worth 10 Malaysian sen or about 2.45 US cents.

Assuming the debt restructuring goes ahead AirAsia X’s equity value will still be under water.

But what was most astonishing, almost unreal, was the airline saying it hoped to reconstitute its debts of USD16 billion into a principal amount of MYR200 million (USD49 million) and offering lessors a horrifying haircut of 98%.

That means for each dollar owed, you get 2 cents back.

The picture presented in the media is of an airline crippled by Covid, its All-Stars (as AirAsia’s staff are affectionately called by its co-founder) going down gallantly, even if unavailingly, against the diabolical disease.

The real story is more complex, but of great interest.

It is the story of a bad mistake, of greed, which has left both airline and Airbus worse off in terms of finances and reputation than it need have been.

It has gone unacknowledged, as many airline errors tend to do, and has been almost buried under the powerful emotions stirred by a dreadful virus and the inevitable clash between fact and fiction.

Did Airbus seriously believe, in spite of generous discounts, that AirAsia X could manage an order of close to 100 widebody jets worth in excess of USD5 billion given its already weak balance sheet then?   

Today the discount carrier holds almost a quarter of the A330neo order book.

Airbus has little choice now but to go along with Fernandes’ bravado, that publicly they both adore one another and as the flamboyant showman deftly puts it, “joined at the hip” much like Siamese twins.

The AirAsia boss is crafty and famous for being outspoken. Born Malaysian Indian he nevertheless possesses the Irish gift of the gab, leading many to read his recent remarks on Airbus as a double entendre.

Neither manufacturer nor lessors exposed to AirAsia X have the stomach to see the carrier, no matter how flawed its business model is or how unlikely it is to succeed, go bust.

The pressing priority, for Airbus, is to ensure the continuation of its A330neo programme, which will be in tatters if AirAsia X fails. 

It is at risk of losing as much as USD12 billion if pre-delivery payments and future debt calculations for aircraft purchases are taken into account.

For the lessors, recovering some of the debts owed to them – even with hideously high haircuts – are preferable than being left with nothing.

Many among us believe the aviation industry has no doubt changed as a result of Covid-19, but the problem lies in believing it has changed for the better.

Guff in the time of corona

Barely 63 years and two months after Malaysia celebrated its independence on 31 August, its citizens received a belated birthday note from the flag carrier: we are bleeding USD84 million a month, says the airline’s parent company, and need billions to stay in business.

Another restructuring therefore, is to be undertaken by Malaysia Aviation Group (MAG), the holding company of Malaysia Airlines Berhad (MAB), to keep the national airline afloat.

In 2014 Khazanah Nasional Berhad (KNB), Malaysia’s sovereign wealth fund (SWF) and MAB’s sole shareholder, laid off 6,000 of the carrier’s employees in a massive overhaul that cost over MYR6 billion.

KNB’s 12-point plan then called for the creation of a newco. It delisted the previous Malaysia Airline System (MAS) at the end of 2014 and transferred operations and assets to the newly-formed MAB in 2015.

Last week MAG confirmed it had written a letter to its lessors, seeking significant reductions on monthly jet rentals. One leasing firm claims the airline is asking for as much as a 75% haircut. 

To put things into perspective, MAB operates six Airbus A350s, currently leased at USD1.2 million per aircraft each month. Factoring the discount, the rental of each plane would be whittled down to just USD300K a month. 

It has other leased aircraft in its fleet, including 21 Airbus A330-200s/300s and 48 Boeing B737-800s. The jets are mostly idled since March due to Covid-19.

MAG says it will not be able to pay its rentals after November 2020 without fresh funds from KNB.

The group’s current liquidity as of 31 August 2020 was USD88 million; it can draw an additional USD139 million from KNB. It is unclear how much debts are in the books.

KNB will pump in USD1 billion (MYR4.15 billion) in 2021, according to the letter, only if the lessors agree to the airline’s request. Additionally, KNB will also capitalise at least USD1 billion of shareholder advances.

If all this does not materialise, MAG will go to court to restructure.

The move is not unexpected. Other flag carries in the region, such as Thai Airways and Garuda Indonesia, are seeking court protection from both creditors and lessors.

Many carriers are emboldened by the success of Virgin Atlantic, the airline partly owned by British billionaire Richard Branson, in getting a high court approval to restructure under Part 26A of the UK Companies Act of 2006, and recognised in the US court, too (following the carrier filing for Chapter 15 bankruptcy).

A key component of this new ruling is that the court may exercise its discretion in using a “cross-class cram-down” procedure. This means if at least one lessor votes to agree to the proposal, the court can order other lessors to be bound by the decision, even if they disagree. 

It is unclear if MAG will succeed in a London court but an executive at another aircraft leasing company says the airline will apply for protection in Kuala Lumpur if it fails to convince an English judge.

“They are determined to bulldoze their way through,” he adds.

And in case that does not work, says the letter, the shareholder (KNB) “intends to divert all efforts and funds to an alternative company with an existing air operator’s permit to ensure connectivity for Malaysia.”

This could mean shutting down MAB and potentially using another MAG subsidiary with existing AOC – either MASwings or Firefly. There are even whispers of a potential tie-up with its cash-strapped rival, AirAsia X.

KNB has rejigged MAS before, in 2014. Existing lease contracts were then novated, paving the way for the newly-formed MAB and its then German CEO to renegotiate terms with lessors.

Kill or cure?

Many Malaysian companies (and workers) need help from the government to survive and to prevent from going bust, thereby reducing the prospect of a lengthy recession.

MAB is not one of them.

Whilst the finance minister has repeatedly stressed his government’s unwillingness to bail out any airlines, its own SWF (KNB is administered by MoF Inc and therefore, represents the government) is doing the bidding for MAB, causing confusion.

“Khazanah’s goal is to have Malaysia Airlines achieve healthy, positive margins comparable to its peers, and ultimately provide a positive return on our investment,” KNB says in an official response to the story that was first reported by news agency Reuters.

In reality, however, KNB has failed to rehabilitate the airline.  

Since becoming a 100% shareholder of MAB in 2015, the return on its investment has been diabolical.

MAB posted a loss of MYR1.12 billion that year, followed by a MYR438 million deficit in 2016, another loss of MYR812 million in 2017 and a loss yet again in 2018, of MYR777 million, for a total of MYR3.15 billion in the past four years.

It is estimated the national carrier has received, and lost, over MYR25 billion in the past two decades. MAB-related impairments in 2018 alone was MYR3.1 billion, almost half of KNB’s total impairment of MYR7.3 billion.

MAB has yet to file its earnings for 2019 despite its CEO claiming it had made significant improvements last year – “short of 0.7% of targeted revenue for 2019” and “record-breaking passenger RASK results in 2Q to 4Q 2019, the highest ever recorded in 3 years.”

MAB was moribund long before the arrival of Covid-19. Any attempt to blame the health crisis to gain government and public sympathy (and money) is dishonest and devious.

Those who insist the airline is an enabler of Malaysia’s economy need to ask key questions: (a) would a MAB collapse cause a contagion in Malaysia? and, (b) are there other options than using taxpayers’ funds to save the carrier?

The respective answers are “no” and “yes”.

As we have argued before, if MAB were to go under, the accompanying loss of capacity would be quickly replaced by other carriers – in Malaysia’s case, AirAsia and Malindo.

A taxpayer-funded rescue of MAB would just prolong the pain and the losses, while extending a lifeline to an inept and incompetent management.

The best way to help MAB is not to infuse more money but rather, creative destruction: let it die and rebuild a new entity, with a new management, strategy and vision, run by Malaysians who fully understand the aviation industry.

The aviation landscape will be drastically transformed post-Covid-19. Despite government support, many airlines, including MAB, will be losers, if still led aimlessly by managers and shareholders with obsolete ideas.

Ants in your pants

When the current CEO was appointed as head of MAB end-2017, he told the local media: “I’m not the smartest kid on the block, but I have a heart of rock.”

A person with a rock heart, according to the Oxford dictionary, is a “cold or unfeeling person.” 

Colleagues describe him as neither cold nor unfeeling, but “expressive”.

He once expressed his devotion to all 13,000 of MAB’s employees, a la Tom Cruise in the movie Jerry Maguire, declaring: “I love every single one of you, you guys complete me.” 

Although he admits to not being the sharpest tool in the box, MAB’s commander-in-chief has unconventional ways to rally his soldiers. 

He writes to the company’s workers regularly, sometimes praising, sometimes cajoling and occasionally reprimanding, but always reminding them who is in charge.

“My dear colleagues, as your top leader…” reads the start of one message. In another he vows, in Churchill-like manner, to “fight tooth and nail in the trenches, side-by-side with all of you to take us where we need to be…”

His most memorable (thus far) contribution during Covid-19 is a YouTube video – “Rise Above Our Differences” – a 4-minute long clarion call for the demoralised troops to act like ants.

“While a single ant may not be able to achieve much, the colony, when working together, becomes truly something awe inspiring,” MAB’s chief ant observes.

Many older Malaysians look back nostalgically on a time when MAS (the precursor to MAB) ranked quite highly in the world.

It produced many skilful pilots (including the incumbent CEO), able and astute aircraft engineers and classy cabin crew that were consistently rated in the top 10 by Skytrax and others. 

There is, sadly, no justification to save MAB in its current condition. Only hubris. 

Even the ants know that.

Kazakhstan’s flag carrier is cruising

Peter Foster

Peter Foster, President & CEO, Air Astana

Kazakhstan Temir Zholy (KTZ) is the national railway company of Kazakhstan, and the country’s largest employer with over 150,000 staff. 

KTZ’s owners and managers are wholly Kazakh.

Air Astana, Kazakhstan’s flag carrier, is puny by comparison. It employs around 5,000 people, 10% of whom are pilots (a third of them non-Kazakhs) and with slightly over 1,000 cabin crew made up mostly of locals.

Its shareholders are the Kazakhstan government (51%) and the UK’s BAE Systems (49%). 

The airline’s management is a mixed bunch of locals and foreign, led since 1 October 2005 by its president and chief executive Peter Foster.

Foster has a yet to be substantiated theory why flying with Air Astana and its budget subsidiary, FlyArystan, is more popular with Kazakhs than riding the KTZ, particularly during the pandemic this year.

“It’s just a speculation, of course, but I suspect few are willing to spend six, seven, sometimes up to 12 hours traversing across the country in a train when they can do it in 90 minutes by air,” he suggested.

Foster is right, naturally.

The ninth largest country in the world (about 2.8 million sq km) but with one of the lowest population density – barely 20 million as of 2019 – the best way to see Kazakhstan, apart from straddling a horse, is by air.

Having a huge domestic market has partly buttressed the airline from damage wrought by the virus. Load factors on Air Astana and FlyArystan are currently well above 80%.

It helps, too, that a competitor, Bek Air, has ceased operations due to Covid-19.

But like other countries and airlines, Kazakhstan and Air Astana have felt the full brunt of the pandemic in the first half of 2020. Losses have come down and the airline’s cash burn is now about US$23 million.

Fortunately, a government report last month claimed the country has now passed the peak of the virus infection. 

The reproductive number, or R0, which refers to the average number of people infected from a single case, is down by 24%, from 1.2 to 0.89. Kazakhstan’s quarantine regime has been lifted as of 17 August, while strict weekend restrictions remain.

The wearing of masks is still mandatory.

When we spoke, Foster was in a car on his way to the opening of a new airport near Shymkent in the southern region of Turkestan. He had been invited (by the president, no less) to its launch and is confident passenger traffic will rise.

“Demand (for air travel) is significant throughout Kazakhstan,” said Foster, “the unattractiveness of rail travel and the partial recovery (from the virus) are factors helping the airline.”

Air Astana is a small carrier in a massive country that has never pretended to be more than what it is – an air transportation company ferrying people from point A to point B.

The secret to Air Astana’s success is…

Under Foster, the carrier has been largely profitable, whilst being prudent.

He takes pride in never having to seek a cash infusion from the shareholders, even during the darkest (and it gets dark a lot in Kazakhstan) period of the health crisis. 

“We have neither sought for nor are seeking a government bailout,” Foster stressed. “We have obtained credit lines from the banks and this was on the back of 18 years of track record.”

The track record is indeed very impressive.

In 2019 Air Astana posted a net profit of US$30 million, up from US$5 million the year before. In the process it carried just over 5 million passengers, an increase of 17% over 2018.

Last year Skytrax, an international air transport rating organisation, voted it “Best Airline in Central Asia and India” – the airline’s eighth in a row.

There are plans to expand the network post-Covid-19. 

Despite a relatively small population, many Kazakhs are fairly well-off, and becoming more adventurous. 

Amongst the work-in-progress, far-flung destinations such as Danang (Vietnam), Phuket (Thailand) and Sharm el-Sheikh (Egypt) are resort towns Air Astana intends to fly to in the near future.

Dubai remains very popular with Kazakhstan’s middle-class while Antalya in Turkey has seen a solid surge after flights resumed from Almaty and Nur-sultan at the end of August. 

Foster and his team have used the downturn to recalibrate the company. 

Air Astana’s fleet of ageing Boeing 757s and Embraer E190s (replaced by the E190-E2s) have been phased out, with the Airbus A321LR, and its “fabulous product in business class,” now playing a pivotal role on routes to western Europe.

He is cautiously optimistic, though.

“Governments around the world need to get their act together,” Foster added. “A huge capacity has been taken out of the market. At the same time zombie airlines and poorly managed ones must be allowed to go to the wall.”

The risk is real.

A second wave, which is threatening many parts of Europe, is fomenting unrest and instability. 

But lifting borders too late could be a serious, permanent mistake which will destroy the airline industry. 

In an age where populists will do and say anything, politicians who are unable or unwilling to weed out useless airline executives or allow moribund carriers to die, will do more harm than good to a country’s long-term aviation landscape.

It does not take superhuman powers to lead and lift an airline, as Foster has shown since he joined Air Astana – just big doses of discipline, patience and humility.

Investor tells SIA: SQ-ew you!

SIA First 787-10 copy

There is an airline investor who is so upset with Singapore Airlines (SIA) that he has written, via facebook, to Singapore’s prime minister requesting the removal of the company’s chief executive, Goh Choon Phong.

The SIA stalker goes by the moniker Seng Hoo Lim and claims to be both a shareholder and frequent flyer.

What is his problem?

As a stakeholder who had recently subscribed to SIA’s rights issue, he is livid with the CEO for allowing the flag carrier to allegedly accumulate jet fuel hedging losses of S$3.54 billion (US$2.5 billion).

He had implored Goh in 2015 and again in 2016 for SIA to cease its fuel hedging practices which, he claims, had resulted in the airline “losing market share in many markets”.

For the first time in its history, SIA is finding itself in a rare position – being openly criticised, castigated and chastised – by a sizeable number of citizens and the local media, who had hitherto used kid gloves to rebuke the carrier.

Many Singaporeans once assumed that their national airline was largely immune to the vagaries of the aviation industry which had afflicted other airlines.

After all, SIA had never lost money in a calendar year (not even during SARS), leave alone going cap in hand to its major shareholder seeking handouts.

Even the usually mild Business Times joined the chorus of critics, admonishing the once peerless airline on 23 September and positing that, reduced demand brought about by Covid-19 aside, “SIA has major problems to fix”.

It cited the carrier’s poor investment track record in overseas ventures and, with the help of various equity reports, singled out SIA’s controversial bets in the jet fuel futures market.

Gambling on crude prices is a bit like taking a punt on when the virus will be eradicated, if at all. You just do not know.

It is deceptive and volatile and unpredictable. Pretty much like selecting strategies for a World Cup final match: should your team play total football or deploy catenaccio?

Hindsight is always 20/20 and that is hedging.

It is incredibly tough for SIA (and any other airline) to successfully hedge and defend its hard-earned money against crude, a commodity whose prices are less determined now by market forces than by geo-politics.

The best and brightest at many airlines have come up short in the hedging circuit. In principle one does not hedge to make money (good if you could) but one goes into a hedge to reduce volatility.

The cumulative hedging losses pin-pointed by Seng Hoo Lim are undeniable.

More importantly, the costs of engaging in hedges and the duration – what drove SIA, for instance, to hedge so far out into the horizon, for five years?

The airline says it has always been transparent about its hedging policy.

But how does it explain the huge loss (S$1.1 billion) in 2016 when oil traders generally agree it was the least volatile year this past decade?

All things being equal, if CEOs are to be ejected from their posts solely from hedging losses, then very few airline bosses would survive beyond a couple of years.

It is not a good enough reason to boot Goh out on the basis of hedging losses. Other CEOs have lost lots more and been more reckless fiscally.

Admittedly SIA does have problems – existential or otherwise – that need fixing, but those which have been highlighted are mostly structural, including its long-held strategic obsession with high-end, luxury air travel.

These can be quickly resolved.

An SIA state of mind

One thing that is not easily fixed is attitude.

Attitude is everything, they say.

That SIA is able to soar continuously above the competition, retaining its air superiority over some of the wealthiest and most aggressive of rivals is quite a feat.

But SIA’s highly regarded leaders would do well also to maintain a dose of humility at home, on terra firma, and not exhibit an air of superiority over lower-ranking employees.

In short, SIA must listen to, not lord over, its people.

Past and present SIA rank-and-file workers have long grumble over the haughtiness of some senior executives and managers.

Arrogance and the “I know best” approach apparently permeate across Airline House and within the company.

Recently retrenched part-time flight attendants at one of its subsidiary airlines claim they were terminated by a mere phone call, not personally.

Cabin crew at the parent airline are exasperated, too, seeing how management had allowed pilots to strike a deal, agreeing to take deeper pay cuts instead of being culled while those who serve passengers take the brunt of the lay-offs.

Are pilots a special breed, they questioned.

In some ways SIA is a victim of its own success.

It is widely admired, respected and envied because it has excelled in a cut-throat industry, year in, year out.

SIA has flourished and thrived despite its handicap: absence of domestic market and Singapore’s small size (tiny, physically and population-wise).

Changi (and by extension, Singapore) is one massive air hub with SIA providing the extensive network (spokes) that attracts travellers from many continents to transit at the airport and onwards to hundreds of destinations served by the flag carrier.

The airline played its role to perfection previously.

Until now.

If any single event sums up the danger and enormous opportunity faced by SIA, the pandemic is it.

Coming to terms with the need for radical in-house rehabilitation is crucial to SIA’s survival.

Speaking about change is one thing; adjusting the corporate culture is another.

“By dint of will and imagination”

Screengrab of PM Lee Hsien Loong’s parliamentary speech, 2 Sep 2020.

It must be very reassuring to Goh Choon Phong and to all Singaporeans to hear their prime minister emphatically voiced his government’s willingness to defend Singapore Airlines (SIA) against COVID-19 at all cost.

This is not just lip service.

Premier Lee Hsien Loong and his cabinet crafted aid for aviation and aerospace companies six months ago, ensuring the financial and structural damage wrought by the virus did not ruin Singapore’s air hub position in the region.

During a parliamentary debate on 2 September, Lee again reiterated the government’s backing of SIA, regarded as one of the world’s best.

Aviation is critical to Singapore’s economy. The island state cannot survive without air connectivity.

Over 120,000 jobs are directly and indirectly involved, and the sector – including its supply chain – contributes close to S$20 billion (US$14.7 billion) to the state. 

In FY2019/20 SIA – where Goh is CEO – carried almost 21 million passengers while Changi Airport is consistently ranked amongst the world’s top three for over the past decade.

And the Singapore Airshow, which happens biennially and was largely a muted affair in February this year due to the health scare, generated some S$350 million in spending by foreign visitors in 2018.

By comparison the Formula One event hosted by Singapore each September contributes about S$150 million to the tourism industry. This year’s race has been cancelled, dealing yet another blow to the economy.

SIA is the main sponsor for the F1 race and will welcome saving precious millions despite having raised close to S$9 billion from a rights issue and nearly S$1 billion through long-term loans secured on some of the carrier’s Airbus A350 and Boeing B787 aircraft.

Singapore has sizeable reserves, assiduously built up over many years of prudent investing and planning, yet a colossal amount of cash – S$4.4 billion to be exact – that SIA burned through in just two months (between June and August) must have caused consternation.

SIA has been one of the most profitable carriers in the industry. That will change post-COVID-19. 

Even before the pandemic SIA struggled to earn a Return on Equity (ROE) of 10%, registering around 5%-6%. The airline has a Return on Capital Employed (ROCE) of just over 4%, compared to the industry average of 6.5%.

Moreover, the carrier’s over-emphasis in pursuing premium passengers (whose figures have declined each year for the past five years), will hurt its bottomline this decade.

Post-COVID-19 corporate travel will be crimped, with many companies struggling to conserve cash and thus, reducing business trips for staff, especially with Zoom and Webex video conferencing becoming more popular.

Why then is SIA dead set on pushing ahead with luxury air travel?

Retaining the lead over rivals is going to be tougher.

Competitors in the Gulf and elsewhere have got smarter and some are supported by governments with deeper pockets than Singapore.

What should SIA focus on?

The airline has a horrible track record investing in other carriers, marked by huge losses (cumulatively over S$2 billion) in Air New Zealand, Virgin Atlantic and more recently, Virgin Australia.

But SIA cannot allow past failures to be a deterrent.

It must continue to scour the market to acquire airlines and other aviation-linked companies, like airports and those in Maintenance, Repair and Overhaul (MRO).

Such a move is usually fraught with difficulties – both politically and financially – but higher risks bring higher profits.

Why fly SIA?

In the past SIA’s success as a sixth freedom airline was largely due to the government’s strategy of making the island a major hub.

This attracted travellers from Oceania, South Asia and even from neighbouring Indonesia and Malaysia, to use SIA to fly onwards to the US, Europe and at one point, even to South America.

Singapore’s embrace of the Open Skies policy fuelled further traffic growth and an expansion of the hub-and-spoke network.

Today, however, more people prefer flying point-to-point.

Premier Lee believes SIA is still the world’s best carrier and that it will be a “great way to fly once more”.

But the pandemic is threatening to change that.

International long-haul flying, for which SIA is heavily dependent on, will be the last to recover in this environment, after domestic and regional air travel.

Sadly, SIA’s popular but uneconomical A380s will have to go, perhaps not all 19 at once, but at least half to begin with. 

Regardless of what some sly aircraft salesmen are currently peddling – 100 seater planes as part of “right-sizing” the fleet – regional jets are unsuitable for many Southeast Asian carriers, especially SIA. 

For SIA, the solution is to diversify its fleet, which now comprises only widebody planes, with high-performing single-aisle aircraft.

Consider this: SIA retains its long-haul Airbus A350s – admittedly there are more of these than necessary – but removes its A330s and B777s in favour of more B787-9 Dreamliners and more B737 MAX.

The choice of the B737 MAX into the parent fleet will no doubt attract criticism and controversy, but there is method in the madness of deploying the much-maligned MAX as part of SIA’s post-pandemic recovery strategy.

For a start, six B737 MAX are already in SilkAir’s fleet, currently stored in Australia. Once all its issues are resolved, the MAX will be one of the safest, if not the safest, aircraft to fly the skies.

Secondly, since management had already decided to merge SilkAir into SIA, it makes sense to reinforce the MAX fleet.

The alternative to the MAX is the A320neo or A321XLR but there is a huge backlog for these, compared to hundreds of MAX sitting idly in the US, waiting for a home. And they can be had at extremely competitive prices.

Thirdly, SIA needs to reinvent itself. Its fleet of dual-aisle planes will struggle to fill up passengers in the next three to five years. Narrowbodies, on the other hand, are now capable of flying longer (with fewer passengers) on “thinner” routes.

Singapore is SIA is Singapore

It has been said a flag carrier mirrors the image of the country it represents.

To that extent, SIA is a microcosm of Singapore.

It is all well and good the government is committed to securing SIA’s future but how does the airline overcome the physical limitations of Singapore?

“We are here,” reminded PM Lee, “by dint of will and imagination”, referring to Singapore’s spectacular transformation in the past 55 years. 

Like Singapore, SIA’s biggest disadvantage is the lack of hinterland or a domestic market. 

A radio presenter asked us, during an interview last week, if such a handicap (no domestic market) meant SIA is doomed under the current conditions.

On the contrary, we replied.

Singapore produces no oil but has one of the largest refineries in the world!

SIA has succeeded quite sensationally in spite of the absence of a domestic market because it is efficient, disciplined (able to control costs), innovative, and has consistently produced a sound management team .

Even then, overcoming the pandemic will be excruciatingly tough, never mind becoming the best airline in the world again. 

SIA’s future (like Singapore’s), hinges on resetting its raison d’être.

See you in court, Garuda

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a garuda b737-800 in retro livery. pic/kc sim

 

If a week is a long time in politics, the last six months must have seemed an eternity for Irfan Setiaputra, the president director of Garuda, Indonesia’s flag carrier.

Appointed by Erick Thohir (minister of state-owned enterprises or BUMN) in January as the airline’s chief, Irfan has been thrown into the deep end of the pool and, to his credit, is doing swimmingly well amidst the COVID19 crisis.

This past week Indonesia’s House of Representatives gave approval for the government to provide IDR8.5 trillion (USD585 million) to Garuda in the form of mandatory convertible bonds (MCB).

The money won’t last for very long if the move by an international leasing company is anything to go by.

Aercap, the world’s largest lessor, is taking Garuda to court. It filed a claim against the national airline in mid-May, for missed payments amounting to around USD16 million.

The claim by Aercap seeks outstanding rent for 10 aircraft, including nine B737-800s and an A320-200 leased between May 2011 and December 2015.

People within Garuda acknowledged the filing, but said the company was unlikely to meet Aercap’s or other lessors’ demands because “there are several outstanding internal issues that aren’t resolved yet, so a lot of things are up in the air… in the meantime, and during this pandemic, Garuda is unable to pay.”

Twelve lessors have agreed to a restructuring while six have rejected the airline’s counter-proposals.

Garuda’s financials were already shaky before the virus. The first signs of trouble emerged in June 2017 when talks swirled in the market the airline was looking to defer planes it had ordered from Airbus, Boeing and ATR.

By July that year Garuda failed to meet the terms of a USD500 million Islamic Sukuk issuance it had taken out in 2015 and was forced to renegotiate with creditors.

Garuda recently secured a three-year extension on these bonds which were due in June 2020.

A quick look at Garuda’s financials revealed the gravity of the situation.

The carrier is paying around IDR1 trillion (USD75 million) a month on its aircraft leases, including USD1.6 million on a B777-300ER – the airline has 10 – when the rate is now around USD800K.

Garuda was also over-paying on other aircraft leases, including its B737s and that of its subsidiary, Citilink and its A320s.

In 2019 Garuda spent almost USD200 million in finance charges, or about four times from the previous year.

Garuda has liabilities of USD900 million coming due this year, so even the USD585 million raised from the MCB won’t be sufficient to cover the gap.

Under the supervision of BUMN’s Erick, the billionaire magnate who once owned Italian soccer club Inter Milan, together with Irfan, whose background is in mining and technology, Garuda plans to raise another USD500 million – again via the Islamic route – to be arranged by Dubai Islamic Bank, Deutsche Bank and Stanchart.

Even if this Sukuk were to take off, it won’t price anywhere near the 2015 debut.

Then the USD500 million paper was priced at 5.95% and was oversubscribed four times. The deal was structured as a Wakalah contract, and made Garuda the first non-sovereign USD issuer out of Indonesia.

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a classic American motorcycle and two British bicycles were allegedly smuggled into Indonesia on board an A330-300. pic/kc sim

 

A Harley and two Bromptons

The airline has been plagued by alleged corrupt practices for some time.

In May its former CEO Emirsyah Satar, an ex-Citibanker who ran the carrier from 2005 to 2014, was found guilty of accepting USD3.4 million in bribes and for laundering USD2.5 million.

The graft case was linked to kickbacks from the purchase of Airbus A330s, A320s, ATR72-600s and Bombardier’s CRJ1000s along with the acquisition of Rolls-Royce Trent 700 engines.

He was sentenced to eight years in prison.

Ironically, Garuda is now looking for potential buyers for all six of the 18 CRJ1000s it owns. Twelve of the planes are leased from Nordic Aviation Capital (NAC).

Garuda struggled from the get-go to make the CRJ1000s profitable.

Airline officials said they were unhappy over the aircraft’s lack of product support and difficulty in sourcing for pilots type-rated for the jet within Asia.

Additionally, the CRJ1000s also needed to take off from runways that are at least 2000 metres long, making them unsuitable for many airports in the archipelago.

All CRJ1000s are currently grounded.

But perhaps the most brazen abuse at the airline involved a classic 1972 Harley-Davidson motorbike, specifically known as the Shovelhead, and two Brompton folding bicycles – all allegedly smuggled in a new Garuda A330-900neo on a ferry flight from Toulouse to Jakarta.

The illegal items turned out to have been bought by none other than Garuda’s then-CEO Ari Askhara, who was summarily sacked by minister Erick. Local media reported the former airline boss is likely to face criminal charges.

Garuda’s ill-advised choice of having a mixed fleet, including those for its subsidiary Citilink, is something current CEO Irfan is keen to resolve. Quickly.

The carrier’s 13 ATR72-600 turboprop planes, leased from NAC, are not fully utilized, according to an airline staff.

The Garuda official said the airline will stick to Airbus and Boeing widebodies and narrowbodies post-COVID19.

“Some people have tried to convince us the merits of regional jets but after our experience (with the CRJs) we don’t think that’s viable for Indonesia, or even Southeast Asia. If it were, the RJs would have been a huge success by now.”

 

 

 

 

“Move beyond” the unknown

HK Star Ferry

The iconic skyline of hong kong island. pic/shukor yusof

 

“I am in dread of the judgment of God upon England for our national iniquity towards China” – William Gladstone

 

Modern China is a beast both the US and the UK cannot, however much they try, control and corrugate.

The transformation of China has been long and painful.

Economic and social changes have taken place in a very short space of time, shorter than during its past history, starting from Deng Xiaoping’s “Open Door Policy” in 1978 to the Tiananmen Square protests in 1989 and most recently, President Xi Jinping’s move to turn Hainan into a free trade port.

In just over four decades China has morphed from a backward, under-developed society into the world’s second-largest economy, and the second-biggest holder of US treasury debt (USD1.08 trillion against Japan’s USD1.27 trillion).

It is difficult to fully appreciate and grasp the changes of the past 40 years without studying and understanding China’s political system, social structure and economic institutions in the past, particularly events in the 18th and 19th centuries.

There were several major forces that shaped modern China. After its defeat to Britain in the Opium War, followed by the Anglo-French occupation of Beijing in 1860, China’s elite knew the country had to change if she was to survive.

The Middle Kingdom had much to learn from the barbarians.

The Chinese initiated the Self-strengthening Movement in the 1860s, using the buzzword of the day then, coined by Wei Yuan, a famous scholar, that went thus: “learn the superior barbarian technique with which to repel the barbarians.”

Alas, this movement – focused mostly on military strength of the West – proved insufficient, evident during the defeat to the Japanese in 1895, and the Chinese realized any meaningful attempt at modernization must include political reform.

China, Hong Kong & the West

In recent weeks unrest in Hong Kong over the introduction of a national security law has led observers, particularly those in the West, to question if the “one country, two systems” principle has any relevance.

China’s view though, is this: there is only China – the One China Policy – and that all of it is under one single, indivisible sovereignty, which also includes Taiwan.

But Taiwan is another story, for another day.

And Taipei should heed the warning from China that any attempt to give refuge to Hong Kong “rioters” would only “bring harm to Taiwan’s people”.

Hong Kong’s transformation, from a British colony to a Special Administrative Region of China, had been relatively smooth until mid-2019 when the Hong Kong government introduced an “extradition bill” which, if enacted would have allowed extradition to jurisdictions which Hong Kong currently does not have agreements with, including the mainland and Taiwan.

Following widespread opposition and subsequent rioting, the bill was formally withdrawn on 23 October 2019.

However, confrontation and tension between the territory’s leadership and many Hong Kongers remain on-going and have damaged business confidence as well as the territory’s standing as a financial centre.

Beijing’s recent decision to impose the national security law has further aggravated the situation.

Here’s what we know about this new law so far: read it here.

Any talk of secession from the mainland, undermining the authority of the Hong Kong government, collusion with foreign forces and using violence against people are deemed criminal acts.

Many residents worry, too, over China possibly establishing its own institutions in Hong Kong to handle security affairs.

When Britain handed its colony back to China in 1997 both sides agreed, as part of the Sino-British Joint Declaration, on a mini-constitution known as the Basic Law, along with the “one country, two systems” policy.

However, in 2017 Beijing said the accord with the British was irrelevant.

The proposed new law, according to China, is a critical step in establishing and improving the legal system and enforcement mechanisms in Hong Kong, as well as to safeguard national security.

There are fears, amongst locals and British (and EU) politicians that Hong Kong’s judicial system will be like China’s if the new law is passed.

The British government is so upset that its premier Boris Johnson is offering eligible Hong Kongers almost 3 million British National Overseas passports, a document which allows its holders to live and work in the UK.

But has Britain conveniently forgotten something?

When Hong Kong was under British rule, the Treason Act of 1351, also known as “Statute of Treasons”, applied to the colony. The Act was designed to punish people plotting or “imagining” the death of the monarch, “levying war” or “adhering to the King’s Enemies”.

What does all this mean to Cathay Pacific Airways?

Cathay Pacific Airways is living on borrowed time.

Despite assurances by its chairman that the airline’s long-term future is bright, doubts remain.

For one, Cathay’s destiny is inextricably linked to the fate of Hong Kong.

China has no intention of destroying Hong Kong but many of the territory’s citizens – with their incessant demands for greater freedom (some even clamoring for independence) and willingness to use violence – are jeopardizing their own prospects.

Both Cathay and Hong Kong’s Chek Lap Kok Airport depend much on tourism, as do the hotels, theme parks, restaurants and retailers on Hong Kong Island, Kowloon and The New Territories.

The riots and protests in the second half of 2019 resulted in tourist arrivals falling by almost 40%.

And the jobless rate rose to 4.2% in March 2020 (from 3.7% in the Dec 2019 to Feb 2020 period) – the highest in nine years – partly due to COVID-19 as well as the political impasse.

Hong Kong is experiencing negative economic growth – its first in a decade.

Its position as a financial hub is at risk.

No airline can flourish under such bearish conditions.

There is the HKD39 billion (USD5.03 billion) rescue package crafted by Morgan Stanley allegedly within three months for Cathay, but money burns fast in the airline business and it won’t guarantee the airline’s survival long-term.

Here are more details of the Hong Kong government bailout.

Morgan Stanley is earning nice fees at the expense of struggling carriers. (In July 2019 the Wall Street investment bank was mandated by Malaysia’s Khazanah Nasional to find a fix for Malaysia Airlines. So far, nada.)

As Hong Kong’s economic future hangs in the balance, so does Cathay’s.

Beijing has shifted its focus to Hainan Island, a 50-minute flight from Hong Kong.

And the Chinese are hoping it can lure foreign investors to the balmy island after President Xi announced the creation of Hainan as a free trade zone.

This isn’t just empty talk.

A new airline, Sanya International Airlines, is to be launched soon.

It will be partly owned by China Eastern (51%) and the rest by Juneyao Airlines and Trip.com.

Hainan is nearly 30 times larger than Hong Kong and is popular amongst mainland Chinese as a resort destination. It is the venue for the annual Boao Forum and touted by Beijing as the “Hawaii of Asia”.

Unlike the mainland Chinese carriers, Cathay’s disadvantage (similar to Singapore Airlines) is that it has no domestic destinations. It has high labour and operating costs and according to an ex-executive, a pestilent workers union.

Finally there is the small matter of Cathay largely controlled by the Swire Group (through Swire Pacific), a conglomerate based in both Hong Kong and London, whose top management remains quintessentially upper crust English.

The majority, or 80% of the company’s 130,000 employees (working in diversified sectors such as property, beverages and marine services) are located in China, Hong Kong and Macau.

Unlike its rival Jardine Matheson Holdings (which started life as drug peddlers, long before the cartels of Colombia), Swire has had a better relationship with the mainland.

But the Chinese have long held a grudge against the British (and other Europeans). The sight of tai pans still roaming around in Hong Kong must rankle a bit with the mandarins in the Party.

In the world of realpolitik it would be judicious to note that Anglo-Chinese relations, while currently cordial, are veering towards antagonism following Britain’s (and the US) stance on Hong Kong.

To paraphrase Harvard economist JK Galbraith, the future of Hong Kong isn’t the American or British future. But it is the Chinese future.

 

 

 

Air travel will be costlier and more tedious

Yellow fever card

a yellow fever card. will passengers need a covid-19 card before they are allowed to fly in the near future?

 

Like the International Air Transport Association (IATA), the Association of Asia Pacific Airlines (AAPA) – a trade association – is extremely worried about the future of airlines and the plight of its members during the current pandemic.

IATA has been urging governments worldwide (on behalf of nearly 300 of its members), and almost on a daily basis, to remove unnecessary measures and processes it believes would only impose additional burden on airlines that are barely able to stay alive.

In Asia Pacific, AAPA this week called for governments in the region to apply the three “Cs” – consistency, coherence and coordination – in the implementation and execution of health procedures such as contact tracing and social distancing that are done together with airlines, airports and health authorities.

There are 15 airlines under the auspices of the AAPA, including Air Astana, Bangkok Airways and EVA Air.

“Let’s follow the facts, the science,” urged Subhas Menon, AAPA’s director-general. “Airlines are not vectors of infections and we need to continuously review the rationale for some of the travel restrictions that have been imposed.”

And in order to allay the public’s fear over air travel safety, the processes introduced (at airports for instance) must not be cumbersome but based on accepted medical standards.

In its statement, the AAPA suggested many of the precautionary health measures ideally should be best done before passengers get on board a plane.

Added Menon: “Wherever possible processes such as travellers’ health declarations should be automated and made available on mobile devices for the convenience of the travelling public.”

There have been much discussion on the “new norms’ of air travel as a result of COVID-19 and one of them is for each passenger to obtain a health certificate, much like the yellow fever card (shown above) required for travel to certain countries such as those in Africa and Latin America.

Subhas AAPA DG mugshot

AAPA director-general Subhas Menon

 

As it closely monitors developments in the region, AAPA takes its cue from IATA and other global aviation agencies such as the International Civil Aviation Organisation (ICAO) and the Airport Council International Airport Council International (ACI).

“IATA has shown leadership,” said Menon, “and it has been working very closely with ICAO, ACI along with governments and airlines in order to streamline a multi-lateral framework. It’s complex and governments must talk to each other…”

Changing face of aviation

In line with AAPA’s push for more automation and digitisation as part of the passenger experience pre-flight, the use of technology is going to continue to play a key role, according to SITA or Société Internationale de Télécommunications Aéronautiques.

The world’s leading specialist in air transport communications, SITA’s technology solutions are found at airports worldwide.

But despite its huge focus and emphasis on state-of-the-art software and heavy use of artificial intelligence (AI) – 95% of all international destinations are covered by SITA’s network – it is ultimately people who will be behind the recovery.

“The human factor is essential,” said SITA’s Asia Pacific president Sumesh Patel.

“It’s fair to say none of us has seen or experienced this (COVID-19) sort of thing before and now we’re seeing its economic and human impact on our lives. So even if we continue to focus on technology there is always the human element.”

Among the technologies already implemented at some airports in Asia and beyond include Smart Path, touted as the most comprehensive whole-journey identity management solution, especially in the current environment of mandatory mask wearing at airports.

KLIA SITA

facial recognition at kuala lumpur international airport. pic courtesy of sita

 

SITA said it is acutely aware of the devastation the virus has had not just on airlines but also on airports.

“We are working very closely with our customers and stakeholders,” said Patel.

“It isn’t just about the economic and financial pressures but driving cost-efficiencies (when airlines and airports recover). Passengers are accustomed to tough security measures after 9/11, now there is also the additional health requirement.”

As part of the recovery process SITA envisages radical changes in the way the air transport industry operates.

Part of this “new normal” will see more adaptation of technology for touchless air travel, such as SITA Flex, where passengers are able to use their own mobile devices without touching an airport kiosk, a solution already in place at San Francisco Airport.

What it all means is an industry moving towards the “mobile-enabled journey” where passengers are kept updated and informed throughout their movements at the terminal, without actually having any contact with another person until they reach the boarding gate.

While all these advancements in technology and gadgetry are helpful and negates unnecessary contact (and potential exposure) to bugs, there is a cost – in terms of money and time – to it.

 

 

Airlines hedge and (often) lose money

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sia’s first airbus a350xwb. pic courtesy of airbus

 

Nobody knows for sure what oil prices will be in the next five trading days, leave alone the next five years.

Yet Singapore Airlines (SIA), widely acknowledged as one of the savviest carriers in the world, has placed bets on the highly volatile and unpredictable jet fuel market for the next – wait for this – not one, not two, but five years.

The fuel hedging contracts the airline has gone into will last until 31 March 2025.

On 8 May 2020 SIA released a statement saying the collapse of crude recently will result in a loss for the company for the quarter ending 31 March 2020.

Singapore’s flag carrier also warned that it expects to register a net loss for the financial year April 2019 to March 2020 (earnings results are due on 14 May) – the first in its history.

This is not the first time SIA has gambled – and lost – on the futures market.

In 2017 the carrier similarly hedged five years into the future, leading some observers to ask: is the company a full-fledged airline or is it now partly moonlighting as a derivatives trading firm?

In 2014 when SIA had hedged jet fuel at an average price of USD116/bbl it suffered losses when the price of the black gold plunged, resulting in spot market prices of USD85/bbl.

American Airlines, the largest US airline, completely went off hedging after oil prices plummeted in 2014, with its president telling the media then: “Hedging is a rigged game that enriches Wall Street.”

Crude oil’s astonishing decline in recent weeks (at one stage it was trading under water) reminds us, too, of events over a decade ago. In 2008 and 2009 SIA, Cathay Pacific Airways and the major Chinese carriers reported millions in losses due to wrong-way bets on fuel.

SIA now says it is going to “pause and plan to monitor developments closely before entering into any additional hedges.”

To hedge or not to hedge, that’s not the question

Many airlines, especially those with good credits, go into hedging some portion of the anticipated cost of jet fuel purchases over the next few years (typically between 12 to 24 months) as an insurance policy, to cut the risk of losing money if oil prices spike.

Airlines also have the option of remaining unhedged and impose fuel surcharges instead.

Fuel typically makes up around a third of an airline’s operating costs (when they are flying, not grounded as is the case now).

And jet fuel hedging is a complicated and expensive process that takes several forms, including contracts to buy a fixed amount of fuel at a fixed price at a future date, and collars, the right to buy fuel within an agreed band of prices.

The former CEO of British Airways, Rod Eddington, once remarked: “When you hedge, all you do is bet against the experts of the oil market and pay the middle men, so you can’t save yourself any money long-term. You can run from high fuel prices briefly through hedging but you can’t run for very long.”

The people who benefit from hedging – the investment banks – see it differently.

Of course.

Hedges, they claim, should never be seen as bets on markets because no one knows in which direction prices will move.

Proponents of hedging point to Southwest Airlines, the world’s first true low-cost carrier, and a clever user of jet fuel futures contracts.

Between 2001 and 2015 the airline reckoned it saved USD2 billion on its hedging strategies. However, in the past few years fuel hedges were big liabilities for Southwest, and in 2016 it lost close to USD500 million.

The same can be said of Delta Airlines. In 2016 the boss of Delta admitted his airline cumulatively lost some USD4 billion on oil hedges in eight years.

The future of the futures market

Most airlines in Southeast Asia engage in some form of hedging but for many the challenge is more complex as they need to protect against currency swings when they buy jet fuel, which is denominated in USD.

In its defence SIA says its hedging policy in recent times was based largely on capacity growth and aircraft purchases (mostly widebody planes, especially its 19 Airbus A380s that guzzle a lot of fuel), and that it has never been overly ambitious and will remain prudent in all its financial affairs.

That may well be the case and while SIA would not record an annual loss if not for COVID-19, its hedging programme needs a review given the airline’s dismal track record this past decade.

SIA’s share price will in all likelihood take a beating when the Group releases its results on Thursday. That will make many of its retail investors terribly unhappy despite a rights issue that raised about SGD15 billion in total.

That SIA decided to warn the market about its jet fuel losses after it had received state-backed aid from Temasek Holdings has not gone down well, too.

Why didn’t it come clean about those losses earlier?

Why did it stick to hedging too far out (five years) and at a fairly large volume – 51% of jet fuel at USD78/bbl and 22% of Brent at USD58/bbl when it knew from past experience and recent crude instability there could be much volatility?

And why did SIA hedge crude oil contracts (Brent) on top of the jet fuel contracts?

When an airline combines or mixes contracts as part of its hedging strategy, the fees can be significantly higher as it has to take into account the total cost of hedging versus the benefits of hedging before it can come up with the preferred ratio.

It’s safe to bet that with airlines like SIA, Cathay and Southwest, the future of the futures markets remains bright. They will continue not just to exist, but thrive.

Other airlines who do not hedge or are largely unhedged, such as American Airlines, United and Norwegian, should be afraid. Very afraid.

Around 10 years or so ago, there was a sudden and unexpected oil price spike triggered by a rogue trader who bought a huge number of Brent futures contract while drunk in the middle of the night.

According to this newspaper report the miscreant at one point was responsible for nearly 70% of the volume of Brent traded!

It is speculators (and in the above instance, an alcoholic) that dominate the futures exchanges. The original purpose of the futures markets was to reduce risk, yet today it would appear these have become some form of electronic casino gambling, thereby increasing risk.

And all it takes is just one loony with a laptop to create mayhem.

 

 

Buffett: “The world has changed”

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boeing 737 factory in renton, seattle. pic/shukor yusof

 

“None but great men are capable of having great flaws” – François de la Rochefoucauld

 

When Warren Buffett, considered one of the greatest and savviest American investors of all time, was interviewed in 1994 on how he assessed risks, the Oracle of Omaha simply replied: “Risk comes from not knowing what you’re doing.”

In the past decade Buffett ignored his own advice and, having eschewed airline stocks for the longest time in his career, accumulated stakes in US carriers, including Delta (11%), American (10%), Southwest (10%) and United (9%).

Over the weekend, at a Berkshire Hathaway (the investment group where he is chairman and CEO) annual meeting, Buffett said he had sold the company’s entire stake in all the US carriers.

Berkshire had invested some USD8 billion amassing shares in the four US airlines and “that was my mistake”, Buffett conceded. “We took money out of the business basically even at a substantial loss… we will not fund a company that – where we think that it is going to chew up money in the future.”

In comments that will have far-reaching effects on global bourses starting today, Buffett noted the COVID-19 pandemic could have an “extraordinarily wide” range of possible outcomes.

He also indicated he did not think equity markets had seen the bottom yet. Buffett’s message for investors is simple: steer away from the aviation sector.

Indeed, the outlook is especially grim for the airline business, hit hard by a shutdown of most of its traffic, forcing 17,000 planes to be grounded worldwide and losses of over USD300 billion for 2020, according to the International Air Transport Association (IATA).

Life is brutal for airlines (and its employees) across the globe. The appetite for any form of investment in the industry is virtually nil now.

In Europe, pilots at German flag carrier Lufthansa are offering to take a rather paltry (under the circumstances) 45% pay cut for the next two years. On average a pilot at Lufthansa earns about EUR180,000 (USD190,000) a year. Senior pilots can make over EUR22,000 a month.

Lufthansa D-ABYO 747-800 copy

the “crack cocaine junkie” says ryanair ceo michael O’Leary. pic/shukor yusof

 

A “crack cocaine junkie” airline

 The Lufthansa Group employs some 10,000 pilots and is said to be losing EUR1 million an hour. It is asking for EUR10 billion in aid from Germany as well as Austria and Switzerland, prompting outspoken Ryanair Irish CEO Michael O’Leary to describe the German flag carrier as a “crack cocaine junkie”.

Of all the European carriers British Airways (BA) appears to be the most sensible so far.

The airline was the first to make the bold and brave move of suspending all flights between the UK and mainland China when the virus broke out in Wuhan in January.

And BA has been swift in reacting to COVID-19, true to its ethos of “never an airline to let a crisis go to waste”.

Another Irishman, Willie Walsh, the CEO of International Airlines Group (IAG) – parent company of BA – is also a proponent of non-government bailouts, and had publicly stood by his belief that weak airlines had no place in the industry.

And soon enough BA announced that 12,000 of its staff may have to go – that’s one out of four in the company.

Not only that. BA has axed all its flights to and from London Gatwick, the UK’s second biggest (and busiest) airport.

Low-cost carrier easyjet, whose largest hub is at Gatwick, had earlier grounded all 330 of its planes, resulting in the airport’s North Terminal being shut.

IAG has a solid balance sheet, with liquidity of just over USD10 billion. BA is predicting passenger numbers would take years to recover (and unlikely to pre-virus levels) and therefore, is hoping to slash a quarter of its workers, betting that in the future BA would need fewer employees.

Air Baltic A220-300 cabin

an air baltic a220-300 cabin interior. observers expect the former bombardier c-series jet, now controlled by airbus, to lead the way in the tight regional jet market. pic/shukor yusof

 

Aircraft values, lease rates falling

Fewer workers would be needed not just at airlines but for aircraft manufacturers.

Last week Boeing announced it was raising funds via the fixed income market. The Seattle-based company sold USD25 billion of bonds – its largest debt sale ever – thus alleviating the need to borrow from the government.

The bonds are on top of a USD14 billon loan that had been drawn in March from some 20 banks, funds that would help the company get through the grounding of the 737 MAX aircraft.

Boeing’s credit rating was subsequently downgraded by S&P Global Ratings to BBB- (from BBB), on 29 April, on the expectations that its earnings and cashflow would be severely impacted by the lack of aircraft demand due to COVID-19.

Over the past fortnight airlines and leasing companies have deferred and cancelled orders for the 737 MAX, meaning the US airframe maker would need to cut production to lower demand.

More cancellations can be expected in the coming months, from both lessors and airlines, although some carriers have been offered the choice of converting their MAX order to 787 (Dreamliner) planes.

However severe the next few months turn out to be, Boeing (and the US) cannot afford to allow the MAX programme to be shuttered, according to creditors and lessors familiar with the manufacturer.

The MAX backlog is well over 4,300 planes, despite the cancellations, and once the FAA recertifies the jet, the MAX should resume deliveries in 4Q20.

Meanwhile the pandemic has forced rental rates of Boeing’s 737-NGs lower by over USD150K.

Monthly leases for the 737-800 have dropped to between USD200K and USD220K (partly due to Virgin Australia going into administration) and the 737-900ER can be had for as little as USD230K to USD240K.

The termination of its joint venture with Embraer is a positive, as it saves Boeing USD4.2 billion although the company would lose access to the 90- to 120-seater regional aircraft business – a small price to pay in a segment that will see Airbus domination in the next decade.

That said, Toulouse-based Airbus is bleeding cash, too.

It is putting up for sale six aircraft slated for delivery to AirAsia end-2020. Four A320neos are said to be in the market for as little as USD50 million each (or below if you can come up with the cash now), and two A321neos going for around USD60-ish million (both with AirAsia’s configurations).

The A350XWB, Airbus’ state-of-the-art widebody plane, is seeing a decline in monthly rates as well. It is available for a mere USD900K, at least USD200K less than it was end-2019.

Airbus’ A330neo jets find the going just as tough while over 200 A380 superjumbos are grounded and causing much financial distress to its owners. Only one, belonging to China Southern, is in commercial service.

The bright spot amidst all this are the A321XLR and the A220, with the former exhibiting unmatched economics in the current market place and the latter displaying its robustness in the ongoing crisis.

On 29 April Airbus released its 1Q20 results, which highlighted an almost 50% plunge in profits. Read it here

Airbus will be having a town hall later today in Toulouse where more measures affecting its production and workers worldwide are likely to be announced.

 

 

 

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