04-Dec-2012 3:15 AM

South African Airways needs more than a government bailout to pull it out of the financial mire

Analysis

South African Airways bears all the scars of a government-owned legacy carrier in terminal decline, accelerated by continued political fumbling and interference which in Sep-2012 resulted in the mass board walkout and the resignation of three top executives, including its CEO.

The flag carrier is deeply mired in debt, bereft of a positive outlook. A temporary sop of a government guarantee is unlikely to support a turnaround in 2013 and offers little hope of improvement in South Africa's troubled aviation sector while government fumbling continues. Moreover, subsidy of one airline - by providing government guarantees - in a supposedly deregulated domestic market only serves to destabilise competitive operations.

That does not offer a sustainable recipe for an airline industry in a country which relies heavily on dependable commercial air services to support economic activity. Yet, unless its masters in Pretoria miraculously gain, and apply, a clearer vision for SAA, the future promises only the continuing decline of a once proud airline.

Summary

South African Airways (SAA) is a government-owned legacy carrier in decline, facing financial difficulties and political interference.
SAA dominates the domestic market and is pursuing a strategy of regional expansion throughout southern and central Africa.
Difficulties in securing more favorable bilateral rights with other African states are restricting SAA's regional growth aspirations.
SAA plans to replace its less efficient fleet with new aircraft and expand its long-haul fleet.
The demise of other domestic carriers, Velvet Sky and 1Time, improves the outlook for SAA's domestic operation.
SAA's financial support from the government is controversial and seen as creating an unfair playing field in the domestic market.

SAA pursues regional expansion strategy

SAA still dominates the domestic market with its main brand supported by subsidiary LCC, Mango, and regional network provider SA Express and is pursuing a strategy of targeting regional expansion throughout southern and central Africa. This has seen the addition of six new destinations added to the network - Ndola, Kigali, Bujumbura, Pointe Noire, Cotonou and most recently, Brazzaville - extending SAA's African coverage to 38 regional destinations.

The strategy, adopted in 2011 after nearly a year of restructuring, was aimed at allowing SAA to tap mineral rich and developing markets across Africa and take on competition from Middle Eastern carriers targeting the continent.

South African Airways network summary: as at 03-Dec-2012

South African Airways regional route network as at Dec-2012

The strategy appears to have borne some fruit, with African passenger numbers growing 11% in the fiscal year ending 31-Mar-2012, including a 17% lift in business traffic and 10% in economy class on the back of growing demand in the mining and infrastructure development sectors. Load factors also improved 7ppt to 68%.

However, difficulties in securing more favourable bilateral rights with other African states are restricting SAA's regional growth aspirations. SAA needs a larger African network to offset declines in Europe, where in recent years it has steadily been shrinking in size.

The most recent cut to SAA's European network came in Aug-2012, when Cape Town-London Heathrow was dropped after more than 20 years of operation. SAA cited competitive pressure and falling demand in deciding to drop the long-haul route. The UK is still South Africa's largest travel market outside of the African continent with more than 400,000 tourists per year, but their number has dropped 24% over the past three years.

Apart from adding some capacity to its double-daily Johannesburg-London Heathrow services by up-gauging equipment, SAA is deploying some of the spare long-haul capacity to healthier medium-haul markets in Africa, including Abidjan and Accra. It also plans to increase capacity on well performing long-haul destinations in the Asia-Pacific region, including Mumbai and Perth. Three-times weekly Beijing services were launched in Jan-2012 as part of SAA's increased focus on Asia.

Capital needed to acquire more aircraft

SAA in 2013 will start taking delivery of the first of 20 new A320 aircraft to replace its less efficient mixed Boeing 737-800 and A319 fleet. The new aircraft, which will give SAA an all-Airbus passenger fleet, will be delivered through to 2017.

Over the same period SAA plans to expand its long-haul fleet from 24 aircraft to 31. Requests for proposals (RFPs) were issued to both Airbus and Boeing in Jun-2012 for new widebody aircraft. Chairman and acting CEO Vuyisile Kona said on 14-Nov-2012 that SAA needed to place fleet orders "sooner rather than later" to ensure it can response aggressively to competitors and meet demand.

SAA has put out multiple tenders over the last several years for new generation widebody aircraft but has repeatedly delayed a selection. A more modern fleet will reduce operating costs. Fuel accounted for 33% of the group's operating costs in its fiscal year ending 31-Mar-2012, up from 28% the previous year.

But the lack of capital to purchase additional aircraft presents a major challenge for the airline, as its African and Middle East competitors rapidly expand their widebody fleets and concentrate more on South Africa and other African markets.

SAA said international passenger numbers were down 2% in FY2011/12 due to aggressive price competition from Middle Eastern carriers and an over-supply of capacity in the South African domestic market. But SAA reported good results from other African routes in FY2011/12, including Harare, Maputo, Lilongwe, Blantyre, Lagos, Accra, Luanda, and Dar es Salaam. SAA said it would like to operate more services on its African regional network, but is constrained by the slow rate of liberalisation in the market.

South Africa international capacity (seats) by region: 03-Dec-2012 to 09-Dec-2012

South Africa international capacity share (% of seats) by region: 03-Dec-2012 to 09-Dec2012

SAA LCC subsidiary Mango for FY2011/12 also reported a loss as "margins were squeezed beyond recognition". Mango was severely affected by the recessionary hangover, higher costs and increased competition from short-lived new LCC entrant Velvet Sky, which launched in Mar-2011 and suspended services in Mar-2012.

Despite its travails, Mango increased passenger numbers by 12.9% and revenue by 22.2% in FY2011/12. Mango's strong cash reserves, gearing and favourable unit costs mean it should be well placed in the slow growth economy for the next year.

Skywise plans a take off from 1time's ashes

The demise of Velvet Sky and 1Time, a much bigger and more established LCC which ceased operations on 2-Nov-2012, significantly improve the outlook for Mango and SAA's domestic operation as the over-capacity SAA cited in its FY2011/12 results is no longer an issue.

As CAPA reported last week:

The demise of the smaller carriers has in effect returned the South African domestic market to a duopoly of SAA and Comair and their respective subsidiaries.

SAA dominates the market with its main brand supported by LCC subsidiary Mango and regional subsidiary SA Express. Comair operates a full-service British Airways franchise and competes in the LCC market with its Kulula brand. The two groups probably have until about the middle of 2013 to consolidate their positions in anticipation of an inevitable new entrant, likely to come from former 1time executives who appear to be planning to launch new LCC Skywise early in 2013.

Former 1time executives are reportedly planning to launch Skywise, in 1Q2013, initially operating on South Africa's biggest route Johannesburg-Cape Town using two 737-300 aircraft. Skywise founders include ex-1time executives Rodney James, Glenn Orsmond, Michael Kaminski and ex-Sun Air MD Johan Borstlap. The proposed carrier is reportedly still in the process of applying for an operator's certificate. Planning has apparently been underway for six months.

Africa's newest airline, FastJet, which launched on 29-Nov-2012, is also considered a candidate to target the South African domestic market.

SAA's subsidy probably the last thing the airline needs

South African Airways badly needed the partial relief of 1time's demise. The overweight and unwieldy flag carrier has been sinking deeper and deeper into the financial mire, with seemingly few recovery options. But whatever it needs, subsidy can hardly be a complete solution and it needs more than a little temporary relief at home.

Like other end-of-the-line operators, as liberalisation sweeps the industry it becomes increasingly difficult to compete effectively in international long-haul markets. This is a problem that will only get worse.

Even if it were an efficient operator (and it is not), life would have become difficult for what is a model from a different age. To make matters worse, SAA has lost a large part of its skills base and, despite the obvious, albeit belated, government support reflex, the very last thing the loss-making airline needs is further subsidy which does little more than entrench inefficiencies.

SAA's on-going financial support included a ZAR5 billion (USD563 million) government guarantee on 02-Oct-2012 for a two year period effective 01-Sep-2012. SAA has repeatedly had to ask the government for assistance over the last several years as multiple restructuring attempts have failed. The requests are controversial as they distort the playing field, with rival Comair being the most vocal critic.

On 15-Oct-2012 SAA reported a ZAR1.3 billion (USD146.2 million) operating loss on increased revenues of ZAR23.8 billion (USD2.68 billion) for the year ending Mar-2012, up from ZAR22.6 billion (USD2.54 billion) a year earlier. Operating costs increased ZAR3.6 billion (USD401.6 million) to ZAR25.2 billion (USD2.83 billion). Over the last 10 years, the airline has made cumulative losses of ZAR14.7 billion (USD1.65 billion).

Mr Kona has said the airline plans submit a new business plan, in support of a ZAR5 billion government guarantee, by the end of Jan-2013, which appears to be an extension from the original 15-Dec-2012 deadline. The plan would "further energise the airline, rejuvenate its executive management team, strengthen internal controls and maximise the airline's profitability while managing costs", he said.

The guarantee is intended to enable SAA to borrow on the financial markets, allowing it to operate as a going concern and is subject to SAA's new board providing a turnaround strategy. The strategy would include details of financing for the airline's planned purchase of short and long-haul aircraft. But, faced with repeated government reluctance to support substantial restructuring of the company, it is hard to see any new moves achieving more than a temporary respite.

The decision to provide SAA with another guarantee has again understandably upset competitor Comair, which continues to claim assistance is creating an unfair playing field in the domestic market, supporting SAA to fly unprofitably. In support of its request for more government backing, SAA points to a June-2012 Oxford Economics report which calculates the national carrier contributes ZAR8.6 billion (USD967 million) to South Africa's GDP, supporting 35,000 jobs and a further ZAR11 billion (USD1.2 million) in tourism, with 44,000 additional jobs in the sector.

Government interference led to mass resignations

As SAA tries to look ahead, its leadership platform shapes up as worryingly uncertain. Unwelcome interference in the airline's government owner, coupled with inept interventions, have caused SAA considerable upheaval in recent months, provoking a series of mass resignations as it negotiated to secure additional government backing. As CAPA reported last week:

SAA chairperson Cheryl Carolus and seven other board members resigned on 26-Sept-2012 and 27-Sept-2012 following a "breakdown in the relationship with the shareholder". Ms Carolus and South Africa's Minister of Public Enterprise Malusi Gigaba had earlier disagreed over whether SAA had a long-term strategic plan to justify the airline's requirement for another ZAR4-6 billion (USD450-675 million) of public funding requested in Feb-2012.

Ms Carolus on 08-Oct-2012 criticised the government, saying: "We, as a board, were made to look as if we were inefficient, while aspersions were also being cast about the financial statements for SA Express and SA Airlink, insinuating that there may be some cooking of the books." Ms Carolus also said the airline's strategic planning was restricted by slow Government processes.

Ms Carolus said: "We have all the additional government compliance requirements put in place by people who do not understand how businesses work, hampering our progress. We have had to put up with some slow decision-making on the part of our shareholder with regard to some major strategic changes, such as new routes, where competitors have moved faster and gained the upper hand."

On the same day, CEO Siza Mzimela resigned, after just 19 months into the job, along with general manager commercial Theunis Potgieter and general manager legal, risk and compliance Sandra Coetzee. Ms Mzimela said running the airline was "a very demanding and daunting task even under the best of times". She added, "there has not always been a uniform understanding and appreciation of this mandate from stakeholders...as if the operating environment was not daunting enough without this unnecessary discourse and misinformation."

Mr Kano is leading a task team to develop a turnaround strategy for SAA to be presented to Mr Gigaba by 15-Dec-2012. A new CEO is expected to be appointed by mid Jan-2013.

There is unlikely to be a host of well-qualified professionals applying for this "very demanding and daunting task". The position has become a revolving door in recent years and the sudden departure again of almost an entire board along with the airline's main executives can only have created an enormous vacuum and an increasingly destabilised workforce.

Both SAA and South Africa need a platform for sustainable aviation operations

Certainly the global aviation situation creates major challenges for a legacy airline like SAA, but these should not be insurmountable. If the airline is to survive and even prosper, it is time for its owners to stand up and take responsibility for the company's now-parlous state. The blame can no longer be fobbed off as the fault of its management. But the sad succession of professional departures now makes the task of attracting well qualified leaders so much more difficult, not to mention retaining motivation among the airline's staff. If the only management that SAA's owners can tolerate is one which follows the political winds, then the future is precarious at best.

Privatisation is out of the question in these circumstances and, so long as the owners continue on their wayward path, it will remain difficult to attract an international partner. Domestically, the company's partially independent LCC operation has the base to be a genuinely efficient airline, even if it does benefit from support of its bigger brother. Transferring more domestic routes to Mango seems an obvious course to follow, even if unpalatable to politicians and SAA staff. New entry to replace 1time, if it does occur as suggested, should accelerate that process.

Restructuring the entire operation will require single-minded support of a government reluctant to make unpopular moves, but distasteful measures are going to be needed to stem continued losses and further deterioration of the flag carrier. Meanwhile, the country's aviation system remains destabilised, undermining the potential value that an effective air transport system needs to provide.