Air France-KLM and Delta need to hold back as Jet Airways crumbles

Eleanor Steed
By Eleanor Steed August 3, 2018 16:57

Air France-KLM and Delta need to hold back as Jet Airways crumbles

Jet Airways has two months of cash remaining and is grounding a further section of the fleet and selling off a swathe of aircraft.

Naresh Goyal, the promoter of Jet Airways, is desperately trying to sell part or all of his of his 51% holding in Jet Airways in order to keep working capital above emergency levels and see the airline though the next two months of restructuring prior to a possible working capital loan from the banks. Goyal hopes that buyers for a 20% stake can be found through a new issue, but as the airline shares have fallen nearly 10% today alone, it seems unlikely that any issuance will raise the funds required in the mid-term.

Jet Airways has also put on the block all non-core assets such as real estate holdings and it has also put 17 aircraft up for sale. The sale is reported to include just about all of its 777 and A330 fleet, which would be a seemingly manic step given that the long-haul aspect of the airline was supposed to be its core of operations. Indeed, it was clear when Jet was failing before the Etihad rescue that long-haul was killing the airline so why did all involved think that further concentration and expansion of this business model was the future? Was Jet guilty of total reliance on Etihad funds to see through a doomed model, not unlike that of Kingfisher?

Either way the market needs to brace for yet another round of 777s coming to the market depressing values while at the same time the A330 secondary market is going to receive its first real test it seems.

Meanwhile, Jet Airways is renegotiating contracts with vendors across the board to bring costs down, it is also asking pilots and engineers and management to take a 25% average pay cut – protracted negotiations would be expected for such a move but time seems to be of the essence here.

The warning signs have been there for some time: oil prices have been rising steadily, while steady consolidation within the oil-based fuels market has assisted in steadying oil and refined fuel prices on an upward trajectory. At the same time pilot wage increases due to global shortages of pilots (one feeding the other) have been fairly dramatic as have maintenance staff salaries. These are global problems, but as with all things the pressure affects the weakest first, and so it is that with the compounded pressure of high local taxation and a weakening currency the Indian airline market is, as it was some ten years ago, the first to see airlines being driven to the wall. Again,  just like ten years ago, the airlines that are weakest are the ones that are still, right up until the announcements of impending doom, ordering new aircraft in bulk!

Shareholders may yet ask the manufacturers where their due diligence was when large scale aircraft orders were signed recently by Jet Airways or did they think Etihad would be riding to the rescue yet again? Take away the funding and what is left? Kingfisher and Indian Airlines burned through the good graces of banks, Jet Airways would have been gone long before now without Etihad as its white knight. Similarly SpiceJet without its own private investors in shining armour would also have gone under long ago. Today, Jet Airways cannot, for good reason, get working capital loans without a massive concreate turnaround commitment cutting costs across the board by at least 15% prior to any loan agreement being offered. That means Jet has to get those long term cost cuts into place right here and now over the next two to three weeks. But wait! If we take the cost of flying the core Jet Airways routes against the known load factors on the same and the average price charged and then compare those to the mighty IndiGo’s own core routes and load factors and average prices charged, while also taking into account that IndiGo suffered a 97% fall in profits for the quarter ending June 2018 to Rs27.8 crore ($4 million), we can extrapolate that Jet Airways does in fact need to cut costs by more like 31% to stand a chance of breaking even on core routes, which would still then leave many other routes needing to be grounded. We can take this method of assumption because the airline is trying to sell off all 777 and A330 aircraft so one assumes they will be at the mercy of the Indian domestic market once again and the average prices charged therein on the remaining core profitable routes.

To be fair to Jet Airways, we have noticed that many major airlines across the globe have over recent months been slashing costs on premium seats on some core routes, including United Asian routes on East Coast departures and Delta Asian routes on East Coast departures. The list goes on, and this may well be driven in part by the Middle East majors desperately trying to hold on to market share against headwinds, while the Asian carrier market share grows. However, this time all airlines, including Jet Airways, are far leaner and meaner businesses, with exceptional management and an unrecognisable (against ten years ago) ability to adjust to macroeconomic problems and shocks. As such, when we see airlines such as Jet Airways getting into serious financial difficulty, we must not only ask what is wrong with their model, but what is wrong with their market and how does that play out transposed against other major markets across the globe.

It can be strongly argued that a great number of tier one airlines across the globe are not seeing the margins they once enjoyed just 24 months ago, from Emirates to Etihad, from United to SIA and Qatar, from Air France – KLM to Norwegian, SAS through to Qantas, ANA through to IndiGo and SpiceJet. Even Ryanair is struggling to cope with holding its margins and growth trajectory on track as labour costs increase dramatically. All the while the need to finance new aircraft deliveries increases for all airlines across the board. Will this drive even more airlines towards sale and leaseback in the near term? It is a logical assumption to make.

We all knew when the Etihad growth model started its inevitable decline that airlines propped-up within it would have to stand on their own or fail and of course it was no surprise that we and others put Jet Airways at the top of that list or worries all those months ago. The Etihad airline investment model has not worked and where does this latest current partial failure leave the bonds that are set against it? Etihad will no doubt move to guarantee those but again Etihad is being drained of cash through the manic airline investment program of recent years. Etihad still owns a 24% stake in Jet Airways but Naresh Goyal is currently in desperate talks with Delta and Air France-KLM among others to get agreement to a stake sale. Talks with those airlines failed in 2017 because Goyal overvalued the airline. Delta and others might be tempted by a valuation cut of around 30% but they should not be – Delta and Air France-KLM cannot afford a costly venture into the Indian market at a time when even IndiGo is having trouble getting people in the air at a reasonable margin. The time is not right, the market is still far too volatile and Jet Airways must prove that it can cut costs for the long term by a clear 30% while holding on to key routes and assets before an investment can be made. If Delta and others are tempted and take the bait then they are as blinkered as Etihad clearly was.

Maybe all airlines need to remember to be as clear cut as IAG: Willie Walsh, CEO of IAG confirmed today that the 4.6% holding in Norwegian is being sold off. The shares were purchased to prompt a takeover but the two separate acquisition proposals put to Norwegian were rebuffed, the shares are no longer required, the holding serves no purpose for the IAG model and as such the shares are for sale. Walsh stated:  “We’re not going to keep the shares, we’re not an investor. We bought that small stake to initiate a conversation and if that conversation is not going anywhere, as it’s not, we’re not going to hold on to those shares.” Maybe this clear thinking explains why IAG reported strong pre-tax profit growth for H1, despite the headwinds of ATC strikes.

Eleanor Steed
By Eleanor Steed August 3, 2018 16:57