Blog Archive

Tuesday, February 24, 2009

Kenya Airways - Oversold?

I was reviewing share prices vs reported book values & my own 'projections' of profits. So what follows are my own views/opinions.

I will discuss the prospects of various listed firms as businesses with a discussion of the share prices as well. As many of you know I am a huge Warren Buffet fan so I hope I do him justice.

Pick # 1 (BTW, WB does not believe in investing in airlines... I know, I know...)

Kenya Airways (KQ) - Price on 24-02-2009 is 20/-

KQ has faced a tough 3 years with the plane crash in May 2007 - this was at the peak for KQ - and then the hits started;
- elections in late 2007
- post-election violence in 2008
- record high oil/fuel prices
- global financial turmoil in late 2008 & continuing

So the question is whither KQ as a business?

Let's do a SWOT Analysis (I will update it as I get comments)

  1. KQ is among Africa's largest & strongest airlines. Dominant in E & C Africa.
  2. Strong Balance Sheet (Sep 30 2008) shows Kes 10bn in cash/liquid assets. Approx 20/- per share.
  3. National airline thus an advantage in getting airport slots in bilateral agreements.
  4. Privatized for over a decade. GoK owns 23%. KLM 26%. Better management vs government controlled firms.
  5. KQ can survive 2 years of losses while smaller airlines will collapse.
  6. Majority of the revenue is in US$, GBP & Euros.
  7. Aircraft have high fixed costs but deployment is flexible.
  1. Single hub (JKIA) thus exposure to local politics - see effect on KQ during Nov 08-Mar 09 election period.
  2. Inefficient hub (JKIA is controlled by the GoK) leading to inefficiencies.
  3. Reliance on government controlled entities for Jet A1 fuel. KQ faces problems sourcing fuel in various countries including Kenya, Ghana, DRC, Zambia, etc.
  4. Over-reliance on Europe for tourists. Credit crunch in Europe will hurt KQ.
  5. Inflexible (high fixed-cost) aircraft. Only 3 Embraers (E-190). The rest are Boeing jets.
  6. Higher cost airline with large(r), unionized & inflexible contingent of staff.

  1. Africa, especially Sub-Saharan Africa (SSA), has the lowest airline penetration.
  2. Ineffecient government owned/controlled carriers (e.g. Air Tanzania, Air Zimbabwe, SAA) benefits KQ.
  3. Increasing African trade with the Mid-East, Far East, China & India will increase passenger & cargo numbers.
  4. Huge potential in tourism from the increasingly wealthier Chinese, Indians & Middle Easterners.
  5. KQ has become the 'local' or 'regional' airline for many SSA countries e.g. Lusaka-Lilongwe, Lagos-Abidjan-Monrovia, Accra-Freetown, etc.
  6. Global Financial Crisis will enable 787 deliveries to be made sooner than expected.
  1. Ethiopian Airlines has a stronger pan-African presence & better global reach vs KQ. And it keeps growing.
  2. Airlines privatizing - or recently privatized - all over Africa including Air Tanzania, Air Uganda, Air Malawi, etc.
  3. New & expanding Low-Cost Airlines (Jetlink, Fly540)
  4. Low purchasing power in SSA means air travel is a luxury for 99% of the population thus limited growth in the next 5 years.
  5. High & volatile oil (fuel) prices.
  6. Low barriers to entry. Anyone can buy a plane (see Fly540, Air Uganda). Both in Kenya & in SSA.

Financial Discussion

  • KQ has almost 20/- (per Sep 30 2008 balance sheet) in cash or near-cash. The 1H 2008-9 period was barely profitable BUT most other airlines made losses.
  • Oil prices were at their peak in 1H 2008-9 but they have dropped by 65% though KQ entered into unfavourable hedges which will continue into 2009. KQ will see benefits of lower prices in 2009-10.
  • KQ has been aggressively expanding in 2008. KQ will continue expanding into Africa & globally in 2009:
  1. Dhaka (Bangladesh)
  2. Kisangani (DRC)
  3. Libreville
  4. Blantyre (Malawi)
  5. Malabo (Equatorial Guinea)
The good news for KQ is that they can easily discontinue loss-making routes while open new routes rapidly provided they have agreements in place.

So the business is OK. Sustainable. And growing 50% over the next 3-5 years.

Earnings: KQ barely managed 1.59 for 1H 2008-9. I expect a better 2H thus at least 3.50 for FY 2008-9 which leads me to say BUY.

PE = 6x which is great. Cash flow will be lower as KQ spends to expand.
PB = 0.5 (Kes depreciation has boosted value of aircraft/assets but note an offset for US$ loans/liabilities)


MainaT said...

Good piece. I'd have added customer service as a weakness. Infact, its top weakness. 2ndly, given its reliance on European revenue, its not price competitive vs Virgin and BA.
Threats/Opportunities- the entry of direct Delta's direct flights to Kenya doesn't augur well for KQ in its tourism business. But is also an opportunity for GoK to do a bilateral deal such that KQ would be able to fly to Miami.
Earnings outlook remains grim which coupled with cashflow means you won't get compensating dividend so I'd say the entry opportunity into is still some way off.

MainaT said...

Saying all that, KQ stands out not just in Africa but worldwide. Because its making profits when many especially long-haul airlines are loss makers.

coldtusker said...

Cust Serv: Sigh, I agree. Hopefully they resolve that soon. BTW, they hired Lufthansa to help sort that out. I think at the moment the PERCEPTION is worse than reality.

coldtusker said...

Price Competition: They can get away charging more coz they have more flights. And competitive advantage. Good for shareholders.

Delta: It will use Dakar as the 'intermediate' airport. JKIA needs to be upgraded to Cat 1. ASAP. See earlier posts on KAA & JKIA.

BTW, KQ will code-share with Delta (Sky-Team). I think the NBO-Dakar sector might be run by KQ for some flights then change of plane to Delta.

I think most American airline service sucks!

coldtusker said...

Dividend: I expect 1.75 = 8.75% (gross). This is excellent!

MainaT said...

CT-Have you flown KQ in the last 6 months? I've and it wasn't good. Delays of almost 2hrs from Heathrow-problems taking off. Then in Nai coming back they tried being funny ati I had confirmed too early...
Price-the London-Nai route is now going Virgin's way bcos in addition to better price, it also has higher weight allowance.
On DPS, I can get better capital gain + income from EABL.

Maishinski said...

KQ is implementing a CRM system. Hopefully they will look beyond the system into the entire end-to-end value offering.

Its true KQ is one of the more expensive airline. Even when compared to next door Ethiopian.

Am waiting for the shares to hit 5/= again...

coldtusker said...

MainaT: I have not experienced the same problems you have. They do not communicate well.

Lufthansa was hired to advise on improvements. I think they have completed the report. New COO hired last year.

5/-... in your dreams... at the moment!

uginvestor said...

I would concur with you that KQ at Ksh19.5 and a forward PE of 3 is a great long term buy. The only problem I foresee is a situation whereby KQ's management is hesitant to hedge the oil price in future as a result of the losses they have had to suffer due to the current ineffective hedges in place as the oil price tumbles.I have also added this to my blog

coldtusker said...

uginvestor: They should learn from the past problems to improve their hedging policy/strategy going forward.

I think they should hedge at $40 coz the lowest the price can drop is $40 (to $0) but it can still go up & I expect it to.

Warren Buffet feels the $40-50 oil (ok, he has an incentive for higher prices) will not last too long.

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