15-Feb-2013 11:45 AM

ANA's capital-raising and international acquisition strategy raise questions for investors

Analysis

Call it an unusual, even fortunate, position, but some are quietly wondering if Japan's All Nippon Airways has more cash than it has strategic plans to utilise that capital. ANA in Jul-2012 announced plans to raise as much as JPY211 billion (USD2.2 billion) of capital in a move with coincidental timing, or not: just ahead of the re-listing of rival Japan Airlines, freshly emerged from bankruptcy.

ANA said the funds would primarily support the purchase of 787 aircraft, but then ANA gave the shell shock announcement it would invest in foreign airlines. Another seeming reversal came in Dec-2012 when ANA acquired a stake in an airline - but it was the domestic operator StarFlyer.

Press reports in late Jan-2013 said ANA had been in discussions with Indian carriers following the country's foreign ownership relaxation. ANA has given cool responses to the rumour, and either way synergies from an ANA investment in an Indian carrier would be low and the challenges high.

Summary

All Nippon Airways (ANA

All Nippon Airways first announces capital to fund purchases of workhorse 787s - but investors fear dilution

ANA on 03-Jul-2012 announced it would issue upwards of 914 million shares in a public offering and 86 million shares in a secondary offering jointly worth as much as JPY211 billion (USD2.2 billion). ANA at the time said the proceeds would "be applied to capital expenditure, including the acquisition of aircraft, chiefly the fuel-efficient Boeing 787 aircraft (i.e. the 787-8 and 787-9 models), by the end of March 2015 for the main purpose of expanding the international route network."

ANA, when the offer was completed on 17-Aug-2012, ended up raising JPY174.8 billion (USD1.8 billion) by issuing 991 million shares, bringing total shares to 3.5 billion - and causing some investors to worry their value was being diluted, although debt/equity ratio and equity/capital ratio saw improvements. Many offered a neutral position on ANA stock.

As for the 787s, a shift is occurring in Japanese aviation as ANA and competitor JAL seek to expand their international networks after relying on their domestic networks for the majority of operations and profit. ANA and JAL have high costs, limiting growth at the same time Japan's economy lags, which will be exacerbated by a declining population; adult diapers now outsell baby diapers and Tokyo recently reported more deaths than births, according to various reports.

The 787 is seen as a central plank to that strategy (the aircraft's grounding is a significant bump along the way). ANA has traditionally been the more innovative of the two, perhaps owing to its private status, whereas JAL was historically government-owned. ANA was the first airline in the world to order and operate the 787, and its launch order for 50 aircraft was a record for an aircraft launch, and something of a standout considering the depressed global outlook at the time of its 2004 order.

ANA sees the 787 not only being more efficient than aircraft it replaces but delivering economies and performance that enable new routes to be opened. ANA has already used the 787 to open new services to San Jose and Seattle, linking Japan to new cities but also enabling one-stop access across its Tokyo hubs from various points in America and Europe to elsewhere in Asia. Further growth is planned in coming years, especially as ANA leverages joint ventures with United across the Pacific and Lufthansa Group carriers to Europe.

ANA ASK growth: FY2011-FY2013F

Japan Airlines too plans to rely heavily on the 787

The 787 is very much the future for ANA as well as JAL. At one time the world's largest 747 operator, JAL quickly retired its 747 fleet during its bankruptcy re-organisation. JAL even views the 777 (marked as "wide-body" in graph below) as having a flat role in growth; in comparison it is the 787 ("mid-sized" in graph below) that JAL attributes growth to. ANA has not released comparative information, but its back order is indicative of a similar trend: three 777s and 49 787s.

JAL Group fleet plan: 2011 to 2016

While JAL intends to mainly use 787s in international markets, ANA is deploying the 787 extensively in domestic markets as well. But more 787 deliveries will mean more international deployment, which will support ANA's planned growth in international revenue.

ANA revenue growth by segment (JPY billions): FY2011-FY2013F

ANA's launch order for the 787 consisted of 33 787-8s and 17 787-9s, all firm. A top-up order in May-2009 was made for three 787-8s and two 787-9s. ANA in Jun-2012 converted four 787-8s to 787-9s. A Sep-2012 order was placed for 11 787-9s, bringing ANA's firm orders for the 787 to 66. They will be delivered by the end of FY2021. At Boeing's 2013 list prices, ANA's 787 order is worth USD11.3 billion. Standard discounts and delay compensation could easily cut that price by 50%.

ANA took quick delivery of 787s to build up its fleet - as of Feb-2013 it has 17 - and the coming years will see on average a slower delivery pace. Recently ANA has sought to limit annual capital expenditure to about JPY200 billion (USD2.1 billion), with more than half of funds being used towards its fleet.

ANA capital expenditure plan: FY2011-FY2013F

ANA unexpectedly announced interest in foreign acquisitions, restructures to accommodate them

In addition to ANA's statement on using the raised funds to finance the purchase of 787s, was a brief and opaque statement that ANA was also seeking to establish "a financial base that is able to respond in a timely and flexible manner to future growth opportunities, aiming to establish a Multi-brand strategy based in Asia". The statement received little attention - the first part about responding seemed generic while the second part, about a multi-brand strategy, did not seem new as ANA already had two LCC brands: AirAsia Japan and Peach.

But ANA's then-clarified interest to take significant stakes in foreign airlines in Asia and even lend company know-how came out of the blue, surprising many. The process will be gradual as opportunities present themselves and liberalisation permits greater foreign ownership. ANA has suggested it would like foreign majority control, if possible.

The strategy will have its challenges, ranging from ANA's capability to Asia, which unlike Europe is not a buyer's market.

As CAPA previously wrote:

ANA can bring to an airline cash - but perhaps little else. ANA acknowledges its direct operation cannot be exported. Although it speaks of know-how and processes it has accumulated, their use internationally would have limits; Japan like much of North Asia has been a stagnating, not innovative, market. Costs are high, a reflection of fixed costs but also not seeking to cut them down.

The experience of ANA in establishing LCC Peach was that Peach's cost base became inflated as it inherited legacy ANA practices. AirAsia Japan in comparison made a far greater effort to stay at arm's length from ANA, as did Jetstar Japan with partner JAL. Incidentally, the market favours Jetstar Japan because of how little involvement there is from JAL, which had billions in debt before filing for bankruptcy.

LCCs like AirAsia and Jetstar bring considerable intellectual property in terms of making airlines more efficient, but ANA has few such comparisons to bring to the table.

ANA speaks of likely wanting to take a role in management of a carrier it invests in, but even with a minority non-controlling interest, its day-to-day benefits are not immediately clear.

ANA has highlighted it is looking at airlines within Asia where there is "strong economic growth" and at where it can achieve least 8% ROA and 10% ROE. A stake in a full-service carrier should create "synergy" with the ANA brand while an investment in a LCC would provide for "early expansion". ANA would also seek to leverage its "resources and know-how" as well as the "value offered from the ANA brand".

ANA is making corporate changes to support possible acquisitions by moving to a holding company structure. Whereas previously various units (including ANA Wings and AirAsia Japan) were under ANA the airline, a new holding company will look after the individual operations. ANA Wings and AirAsia Japan, on paper, will report to the holding company and not ANA the airline.

ANA increases stake in Japanese airline StarFlyer

ANA's investment strategy proceeded quietly for a few months before another seeming re-direction in which ANA increased its stake in StarFlyer, a predominantly domestic Japanese airline - inconsistent with ANA's stated strategy of investing in international airlines with high economic growth.

As CAPA previously wrote:

On 14-Dec-2012 ANA agreed to take over US-based fund Doll Capital Management's (DCM) 16.61% stake in StarFlyer, increasing ANA's shareholding in the carrier to 17.97%, making it the largest shareholder. ANA's involvement with StarFlyer dates back to 2005 when they agreed to a business partnership (StarFlyer uses ANA's reservation system, but is looking to migrate off it) and 2007 when codeshare services commenced.

The rationale for ANA's move is not clear, but likely grounded in two events: one, DCM wanted to sell its maturing stake and two, ANA is flush with funds following a Jul-2012 equity issue of JPY176 billion (USD1.9 billion). While ANA said the equity issue was to fund purchases of forthcoming 787s, some in the market suspect ANA wanted to steal the limelight - and any floating cash - from rival JAL, preparing to re-list on the Tokyo Stock Exchange.

...

ANA's additional stake in StarFlyer costs approximately JPY2.47 billion (USD27.8 million), representing a mere 1.4% of its fresh funds, so a relatively small purchase. The upside, however, is not clear. StarFlyer has varying profitability. It posted a net 1HFY2012 profit of JPY172 million (USD2.2 million; a 1.4% net margin) with forecasts for a net FY2013 profit of JPY569 million (USD7.2 million; a 2.2% net margin). Its most recent full year results, through 31-Mar-2012, saw the carrier post a JPY966.7 million (USD12.2 million) net profit, a 4.3% net margin, indicating deterioration since then.

Until Jul-2012, when StarFlyer launched a service to South Korea's Busan from Kitakyushu, StarFlyer's scheduled services were all in the domestic Japanese market. StarFlyer has found a niche in the market, operating as a JetBlue-like operation for Japan on trunk routes, as well as from Tokyo to its headquarters in Kitakyushu, home to some important industrial companies that have given support to their "local" airline.

StarFlyer has also gained from receiving precious slots at Tokyo's convenient downtown airport of Haneda.

StarFlyer largest hubs/bases by system seat capacity: 11-Feb-2013 to 17-Feb-2013

The crux for StarFlyer, however, is if it can grow and perhaps even maintain this niche. StarFlyer is the ninth largest carrier in the Japanese domestic market and smaller than Jetstar Japan, which launched in Jul-2012. While the new Japanese LCCs are not in Haneda yet, AirAsia Japan in Feb-2013 remarked Kitakyushu (or Naha) could be its third base in Japan after Tokyo Narita and Nagoya. That would cause further pressure on StarFlyer.

Japan domestic seat capacity by carrier: 11-Feb-2013 to 17-Feb-2013

ANA gives cold response to possible talks with India's GoAir, Kingfisher and SpiceJet

ANA in late Jan-2013 was reported to be in talks, not serious, with India's GoAir, Kingfisher and SpiceJet for an investment. ANA has issued comments ranging from no comment to denying the talks. The possible talks - likely at some general, fact-finding level - follow India's loosening of foreign ownership restrictions, which has also seen interest from Etihad Airways in Jet Airways.

See related articles:

Kingfisher is the much-beleaguered grounded carrier while GoAir and SpiceJet are the sixth and second largest domestic carriers, respectively. GoAir has no scheduled international services while SpiceJet allocated 7% of seat capacity to the international market, not enough to register on the list of top carriers with international seats to/from India.

India domestic seat capacity by carrier: 11-Feb-2013 to 17-Feb-2013

India international seat capacity by carrier: 11-Feb-2013 to 17-Feb-2013

ANA's reach in India is confined to a daily Tokyo Narita-Delhi 767-300 service and a daily Tokyo Narita-Mumbai flight on ANA's specially-configured business jet 737, which ANA CEO Shinichiro Ito told CAPA in Nov-2012 he still considered a "test".

Only two 737s have received ANA's business jet configuration, which allows ANA to test medium-haul, and predominantly business, markets with minimal capacity. Tokyo-Mumbai was one of ANA's initial services with its specially configured 737s. ANA launched Tokyo-Delhi only on 30-Oct-2012, making the city the first in India to receive ANA service with a normally configured aircraft.

ANA serves no other Indian cities and Mr Ito said the carrier would look to work with Star Alliance partners to expand capacity rather than add additional services. Opportunities, however, may be limited as Star has no local Indian carrier (an effort by Air India to join Star failed, although it may try to resume that process while Jet considers joining Star as well) and other Asia-based Star members like Singapore Airlines and Thai Airways, which are respectively the eighth and ninth largest international carriers in India, would prefer to carry a Japan-India passenger on all segments rather than hand the passenger off mid-way. Singapore Airlines in particular is known to be highly independent.

GoAir has hubs at Mumbai and Delhi, ANA's ports, while SpiceJet is strongest at Mumbai. There would be service integration challenges as well as cultural challenges if ANA took a stake in one of the carriers, making the move seemingly unlikely.

GoAir largest hubs/bases by system seat capacity: 11-Feb-2013 to 17-Feb-2013

SpiceJet largest hubs/bases by system seat capacity: 11-Feb-2013 to 17-Feb-2013

ANA keeps options open, so long as it does not alienate investors

Airlines have mixed, even contentious, relationships with investors. Investors favour short-term moves - and high returns - while airlines are naturally exposed to the long-term planning and capital investment the nature of their industry necessitates. Still, ANA receives favourable treatment as it is seen to be profitable, still riding on the "Japan Inc." boom and a straightforward carrier for international, and especially intercontinental, investors to look at. That comes as Japan's stock market has shown strong performance relative to peers as investors become buoyed by the country's possible resurgence, tied to a declining yen (which other nations are now trying to stall, however).

ANA is fortunate to have cash but its unusual problem is that it may very well lack opportunities, and perhaps even ideas, on how to spend it in the near future.

Investors are understandably seeking definition, with pressure mounting as funds (even if small in the grand scheme of ANA's capital) are spent with little clear strategic objective.

There are strategic matters besides spending capital that investors - and ANA - should be worried about, namely how ANA, the largest domestic carrier, will cope as LCCs inevitably cannibalise part of their business and the airline's general low efficiency levels, from high costs to low load factors. The focus may be on recent capital growth, but there is more to ANA's outlook than financial figures.