From junk to undervalued to bust and boom – It is all go

Dino D'Amore
By Dino D'Amore May 13, 2014 20:08

From junk to undervalued to bust and boom – It is all go

So, how many of you out there think it interesting that Airbus should post figures that are slightly down on last year when we are nearing the delivery peak with a myriad of models? Shareholders must be worried. Have production costs increased or have some aircraft been sold off on the cheap? As they say – if it is not the orders or the type of orders sending profits down, then it must be either the cost of production or the prices being paid.

Would you gamble on shares right now? Several surveys of fund managers and brokers have been conducted this year by a number of eminent publications and each are coming out with the same conclusion – a near 99% chance that there will be a significant stock market correction before the end of 2014.

Warren Buffett, Jeffrey Gundlach, CEO of DoubleLine Capital and Euro Pacific Capital CEO Peter Schiff all agree that a correction will “far exceed the damage of 2008.” And with the famous Warren Buffett Indicator breaching sell alert status we have to conclude that a storm is close-by. We were quite big on doom and gloom a few years ago but little did we realise at that stage the willingness of governments to bailout banks and nations and print money. This time around a straight stock crash will leave governments in a real quandary as to if they should get involved so heavily and that factor is one that should be remembered. Keep an eye on gold prices.

Against this backdrop our industry is booming with saturation in some areas as start-ups pop-up across the globe. Now ex-SAA and SA Express CEO, Siza Mzimela is starting a carrier that will be a subsidiary of Blue Crane Aviation, a consultancy, and will be called – Fly Blue Crane. An application for a license has already been submitted for regional services. This newcomer will join Flysafair, fastjet and Skywise in the South African market and given the load factors already being seen in South Africa, I would argue that even this market is now looking like it will see overcapacity over the next five years, which in turn means there will have to be a looser or an investor willing to throw money into a black hole for long periods during a market share war. But of course the real problem in South African aviation is regulation. Skywise saw the Department of Transport (DoT) cancel its Air Service License earlier this year when the DoT said that the license was only valid for a year, and the airline had made no progress since launching anyway. We all recall how both Flysafair and fastjet also faced foreign ownership issues. The hope will be that Fastjet can pull away from rivals at speed.

Qantas Airways is replacing its two year debt with eight year debt as it gets off the ground the first senior unsecured issue from a company with a speculative-grade rating (junk), even so many consider the S&P BB+ and the Moody’s Ba2 ratings to be a little harsh. Deutsche Bank AG has been hired to arrange the sale of eight-year fixed-rate notes. The Australian dollar notes are being marketed to yield about 400 basis points more than the swap rate at this time and might yet settle wide of this. Qantas has little choice but to go on selling debt as it has to keep cash reserves up as it carries on its market share war with Virgin Australia.

Qantas is likely to get the sale off on the back of cost cutting measures and the sale of its Frequent Flyer loyalty business, even though it has A$250 million ($234 million) of local-currency bonds outstanding from April last year. The 2020 notes are yielding 323 basis points more than the swap rate right now from the original 295bp gap. There is also $513.55m of 2016 6.05% securities outstanding in the U.S. dollar market right now.

Meanwhile easyJet load factor data confirms that easyJet shares still have some way to go before a peak is reached, that said, beware Ryanair is rebounding. More interesting for many will be Thomas Cook results and confirmation of the strength of forward summer bookings when it presents interim results on Thursday. It looks like bookings are set to be more or less flat to slightly down on 2013 as customers look to shorter breaks and focus on locations where easyJet and Ryanair have good access running in competition.

But interestingly the story of the week thus far that has caught my attention is that of Jet Airways: It is confirmed that Etihad amended its relationship with Jet in order to pass the Securities and Exchange Board of India (Sebi) test last week. The two air carriers had also agreed under the commercial pact to have a route and schedule co-ordination and joint pricing, marketing, distribution & sales. This was rewritten to drop the word ‘joint’ from the agreement. In the process Etihad agreed to give up its requirement that Jet make Abu Dhabi in the United Arab Emirates (UAE) the exclusive hub for its flights to the Americas and Africa. Now it is highly likely that there was a nod and a wink that this is not a requirement on paper, but is in reality, or else Etihad has thrown a great deal on money down the drain. According to the Sebi order, areas of co-operation listed in the commercial pact will be subject to approval by boards of both airlines with Etihad also giving up its right to recommend candidates for senior management positions in Jet. The clause regarding Jet joining Etihad’s global loyalty programme has been modified to state:  “without any restriction on Jet to enter into any similar global frequent flyer programmes”. Etihad’s right to take the lead in buying aircraft and engines has been replaced with reciprocal arrangements that would be subject to approval of boards of both the airlines also. Another change is that the cooperative arrangements can also be extended to third-party carriers with which Jet or Etihad have similar arrangements or an equity investment, subject to the approval by their boards. Clauses related to governance procedures have also been dropped.

So in effect Etihad has saved Jet and it is holding its business model up via the strategy of developing routes to the US and Africa via Abu Dhabi through an Etihad codeshare but there is nothing stopping Jet from walking away from this at any time, so there is now potential for significant risk for Etihad in this deal, however unlikely that may seem now. It is a good thing that Etihad is not a publicly-listed company as this is the sort of thing that would lead shareholders to question the investment. For Etihad the real gain right now is access to Canada via the Jet Brussels hub that has flights into Toronto in Canada.

Jet Airways meanwhile continues to cut domestic operations and close offices across India in a sign that it is moving in the right direction, but alas this reduction in capacity will be filled by AirAsia India and Tata/SIA within the next few months.

Jet Airways reported its fourth straight quarterly loss of Rs.267.89 crore for the three months ending December with domestic operations showing a loss of Rs.259.7 crore, from a net profit of Rs.10.5 crore the year before. This current quarter is likely to make for very bad reading indeed given that it is the slow season.

Dino D'Amore
By Dino D'Amore May 13, 2014 20:08
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