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September 23, 2018

KQ Finance Team Must Step Up Or Ship Out

Kenya Airways plane at the Airport of Mombasa. Photo/File
Kenya Airways plane at the Airport of Mombasa. Photo/File

One West African lady who was working briefly in East Africa before going back to London where she was based berated a Kenya Airways representative near where I was sitting for bumping her off the flight.

“You call yourself the Pride of Africa oh!” she shouted into the phone. “You are not my pride, you are the shame of Africa.”

KQ, which has the largest Africa network of any airline and flies jetliners kitted in the colours of our national flag, has not drummed up much pride in Kenyans lately.

The Sh12billion loss it announced in the first half of its financial year felt more like a national shame than continental pride.

It is not only the biggest loss ever announced by a listed firm in Kenya, it is also the second time the airline is coming to investors to report a shocking loss.

The other time it reported a big loss was at the end of the March 2009 when it booked a Sh5.6bn loss for the full year.

Back then the losses were occasioned by both a record spike in global fuel prices and loss of forward hedges the company had negotiated before oil prices came tumbling down.

So is KQ’s reported performance a national shame?

We should take a closer look at the situation to reach a verdict.

First, the company’s core business remains the carriage of passengers by air to and from diverse locations.

It’s business model is a hub and spoke one.

With Jomo Kenyatta International Airport as its operating hub, KQ uses landing rights it has secured in many African airports to fetch passengers from those countries using short and long-haul jets like the Embraers, Boeing 737s and so on and bringing them into JKIA.

It then puts them into long-haul jets, Boeing 777s and 787s (Dreamliners) and delivers them to far-flung destinations such as London, Dubai, Bangkok and Guangzhou, China.

It also does the reverse, bringing in passengers from international destinations and putting them in planes that take them to all corners of Africa.

After six months of carrying out these operations, the company as per the law, reported the financial outcome of the same to investors last week.

It generated Sh56bn in revenues during the period under review a slight improvement over the Sh54bn it had generated over the same period the previous year.

This places it on course to remain one of only two listed companies in Kenya to generate over US$1billion in revenues. Safaricom, which generated Sh79bn over the same period is the other.

Its costs over the same period came to Sh61bn up from Sh52bn the previous year. This means, it found itself in a hole of Sh5bn (revenues – costs).

It further lost money on currency and fuel hedges it made during the period.

But the eye-catching loss item was the Sh5bn it booked on write down of 767 jetliners that it lined up for sale.

These assets had to be impaired meaning that they had to now be valued at the realistic market value.

In accounting, assets such as planes are valued at historical cost – what they cost when they were bought.

KQ was caught in a dilemma a few years ago when the leases on its ageing 767s expired but the planned arrival of 787 Dreamliners to replace them was delayed.

Now that the dreamliners have arrived, the board made the decision to dispose of the old planes.

This then triggered the impairment which means, it was recognized that the true value of the planes (net carrying value) was more than the future cash flows they could generate and the terminal value at which they could be disposed.

In other words they could not generate enough cash to justify keeping them.

The effects of this impairment and the decision to write down the assets are many.

Of course, the company’s assets will be reduced since the planes no longer feature in its continuing operations while a few ratios will improve in the future such as return on assets now that the asset base is smaller.

Net profit will also be reduced by including an impairment loss while depreciation will reduce because these assets for disposal cannot be depreciated further.

Without dwelling too much on this, it is important to ask whether the company is headed in the right direction and more importantly, if the board and management are representing shareholder interests.

The decision to dispose of the 767s may have been unavoidable given that new planes had been acquired (KQ now has the youngest fleet in Africa) but questions will be asked as to whether the size of impairment accurately reflects the fair value of these planes?

In other words, are they sure they can’t get more money for them?

Questions have also been raised as to what the true value of the remaining fleet is if the market value of the 767s was so far off the value the company had been reporting in its balance sheet.

Are its other planes overvalued?

Management must also come in for rapping over the losses attributed to hedges for currency and fuel prices.

This is not the first time they are getting burnt and finance must demonstrate it has the necessary skill sets in house to run an international business.

Another major loss based on these hedges and the finance department should be decimated and fresh talent brought in.

The company will have a hard time convincing people to inject money into the company when its Finance guys keep getting battered by local bankers on hedges.

That said, KQ remains a solid business and with the new CEO promising a change in customer service for the better, the company should be back in the black after the Ebola crisis in its bread basket region of West Africa subsides.

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