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Kenya Airways Analytical Note-Final Draft

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Kenya Airways Analytical Note-Final Draft

  1. 1. 1 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com JANUARY 2016 Kenya Airways Ltd Analytical Note – Have the Wings Fallen off Yet Genghis Capital Research Research Analyst: Mercyline Gatebi - Direct Line: +2540 729 250003 – Email: mgatebi@genghis-capital.com Trading queries: Wanjiru Gichuru- Direct Line: +2540202774789- Email: wgichuru@genghis-capital.com Website: www.genghis-capital.com Twitter handle: @genghiscapital Linked In: Genghis Capital Investment Bank
  2. 2. 2 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Source: Annual Reports, Bloomberg Share Price Performance-52 Week Source: NSE INVESTMENT SUMMARY: We initiate our report with a SPECULATE recommendation, based on the price volatility of the stock and its high liquidity. Short–term investors are poised to gain marginal returns on the stock as the company’s management works round the clock to reverse its losses. Based on the turmoil facing the airline, we sought to conduct some analytical tests on the company’s financial strength, transparency in accounting techniques and bankruptcy; with a view of guiding the investor on where the company stands at the moment. The following are the highlights of the tests performed:  The ROE has declined to -231.23% (FY15) from -11.38% (FY14), pointing out to a negative signal as the company is drastically wiping out the shareholders’ value on the stock.  Based on the Altman’s z-score, the firm gave signs of going bankrupt from 2013, when the coefficient of the Z- score went below 1.88 (global benchmark). In 2015, the carrier was close to being declared bankrupt, with a Z- score coefficient of -0.06.  From the Beneish M-score analysis, we concluded it was likely that the firm may have been engaging in creative accounting techniques, both in 2014 and 2015, as its M>-2.22 (global benchmark).  Based on the Piotroski F-score, results obtained indicated that Kenya Airways has an average strength on its financial position for both 2014 and 2015. The key risks facing the company are poor corporate governance, competition from Gulf and Asia airlines, fuel prices volatility and foreign exchange risks which have exacerbated the adverse situation at the airline. We also questioned the benefit drawn from the codeshare agreements between KQ and KLM. Worth-noting is that Europe’s contribution (which forms the majority basis for their partnership) to the total revenues has been on a downward spiral from 26% in FY12 to 22% in FY 15. Based on the poor contributions from other regions due to intense competition, we are of the opinion that the airline should focus on regaining their altitude as the pride of Africa whilst also exploiting other growing routes with lesser competition. Source: Company data, Genghis Research Rating SPECULATE Bloomberg Ticker KNAL KN Current Price(KES) 20-Jan-16 4.80 Market Capitalisation (USD Mn) 71.6 Free Float (%) 46.5% Common Shares Outstanding (Mns) 1,497 Share Price Statistics LTM High (KES) 20-Jan-16 11.50 LTM Low (KES) 20-Jan-16 4.05 Year End March BVPS -4.02 T12M EPS (KES) -18.22 Est EPS -12.75 Beta 0.91 Share Price Performance YTD 8.9% LTM -46.7% Market Performance (NASI) YTD -3.2% 40 50 60 70 80 90 100 110 120 16/01/2015 16/04/2015 16/07/2015 16/10/2015 16/01/2016 KNAL KN Equity KNSMIDX Index Investment Outlook (Year End - Mar) FY13A FY14A FY15A FY16E FY17F FY18F Earnings Per Share(KES) 6.35 -2.25 -17.21 -12.75 -11.30 -9.62 Dividend Per Share(KES) 0.00 0.00 0.00 0.00 0.00 0.00 Free Cashflow Yield - - - -137.6% -129.2% -134.7% EV/EBITDA (x) -27.33x 21.64x 112.02x 30.07x 20.27x 14.66x EV/Sales (x) 0.68x 0.86x 1.38x 1.44x 1.73x 1.82x Price to Earnings (x) 2.06x -3.87x -0.28x -0.24x -1.20x -1.22x Price to Book (x) 0.63x 0.46x -1.22x -0.18x -0.48x -0.31x Book Value per Share (KES) 20.83 18.84 (4.02) (16.77) (28.07) (37.69) Return on Assets (ROaA) -14.96% -6.62% -14.14% -10.64% -8.48% -6.46% Return on Equity (ROaE) -58.90% -34.93% 428.41% 76.04% 40.26% 25.53%
  3. 3. 3 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com TABLE OF CONTENTS Investment Summary - Recommendation Overview, Analytical Test Summaries, Share Price Performance, Investment Outlook 2 Global Airline Industry Trends – Weighty FX Risk, Global Oil Narrative Fragile Nature of Airline Business, Passenger and Cargo Demand Trends 4 Investment Themes – State of the African Economy, Bitter-Sweet Story Elicited by Fuel Volatility, Any Light at the End of the Tunnel, Partnership with KLM Fails to Yield Performance Highlights – Lull Turnover Growth, Slowed Down Cargo Revenues, Operating Losses Surged by 500.3%, Trimmed Growth on Losses before Taxes, Record-Setting Loss Shakes its Wings, Capital Position Stripped off 7 Risks to Investment Call– Is Corporate Governance a Miss in the Airline? Operational Inefficiencies a Common Issue, Competitive Rivalry; a Big Threat to Kenya Airways, Unattractive Ticket Pricing Drags Revenues Down 11 Road Map to KQ’s Success – Cost Reduction, Revenue Management (RM), Infusion of Technology into Pricing and Productivity Improvement, Riding on the Tag Line “Pride of Africa” to Improve Route Profitability Cash and Financial Optimization, Tax Holidays for KQ. 13 Company Analysis – ROE Deconstruction, Altman’s Z-Score, Beneish M-score, Piotroski F-score, Ratio Analysis, HY15/16 Analysis, Financial Summary 14 Kenya Airways Fact Sheet – Operating Statistics, Principal Shareholders, Aircraft in Service , Revenue Mix- 2015 21
  4. 4. 4 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Forex risks impacts consumer decisions, airline decisions and financial impacts. Fuel benefits achieved in many economies apart from Africa. Profitability growth spiked by lower fuel prices, strong demand for passenger travel and a stronger economic performance. Passenger revenues expected to drive revenue growth GLOBAL AIRLINE INDUSTRY TRENDS Weighty FX risk in the Airline Industry: This is the biggest risk that most airlines are faced with. The main foreign currency exposure is the US dollar because the key cost items; fuel, maintenance and overhaul cost (which basically contribute to 40% of the direct costs), are typically priced in US dollar terms: Other significant costs includes aircraft purchases and lease payments. Exchange rate volatility impacts airlines through three main channels; consumer decisions (demand), airline decisions (supply) and financial impacts. Over the last one year, the dollar has strengthened significantly against other major international and regional currencies. This has resulted in revenue growth in many countries as most airlines account for their revenue in dollar terms. However revenue has also eroded by surging direct operating costs and firms reporting both realized and unrealized loses accrued from fuel derivatives. Oil on a Silver Platter for Global Economies, Austere Story in Africa: According to IATA, the airlines fuel bill is expected to fall to USD 135Bn, which will represent 20.6% of their total operating costs. Jet fuel prices have fallen substantially, resulting in many airlines which had running hedges to incur both realized and unrealized losses from their derivative contracts. Fuel prices will be the dominant feature of airline industry economics for the better part of 2016. Threats of slackening consumer demand may cast a long shadow on carriers. The oil price outlook will provide the most important source of macroeconomic uncertainty facing the airline sector in 2016. This effect has been extremely positive for various economies as the cost savings, associated with the fuel, impacted the bottom line directly. The outlook for oil prices remains highly uncertain, with forecasters expecting the prices to average around USD 40/barrel in 2016. We however portend that, despite the economies being exposed to geopolitical risks and lull economic growth, the prices will bottom out at around USD 25/barrel by the end of the year. Given the significance of fuel cost, airlines should focus on improving the fuel efficiency, by replacing the fleet with new aircraft with less consumption. We forecast that fuel efficiency, in terms of capacity use i.e. per ATK, will improve by 2% in 2016 globally. However, this may be less applicable in the African space as most airlines are still using old aircrafts which are less efficient. Fragile Profitability due to Cyclical Nature of Airline Business: Airline industry profitability has improved, returning a profit of USD 19.9Bn in 2014, from USD 10.6Bn in 2013. This return represented a 2.7% margin and a ROIC of 6.1%. IATA projects an average net profit margin of 5.1% being generated with total net profits of USD 36.3Bn. The strengthening industry performance will be driven by a number of factors: 1) Lower oil prices (forecasted to be averaging a lower USD 40/barrel in 2016), 2) A strong demand for passenger travel (+6.9% in 2016), 3) A stronger economic performance in some key economies, (including a faster than expected recovery in the Eurozone) is expected to outweigh the overall impact of slower growth in China and the downturn in the Brazilian economy, 4) Efficiency gains by airlines as illustrated by record high load factors . The industry’s profitability could be best described as “fragile” rather than “sustainable” as airlines are finally commencing to meet the minimum expectations of their shareholders. The industry’s return on capital (8.6%) is expected to exceed the industry’s cost of capital (7.0%) in 2016. The profitability growth could however be slower compared to other industries due to the cyclical nature of the airline business. Passenger Demand Anticipated to Drive Growth in Revenue: Global expected revenue growth is pegged at 0.9% to USD 717Bn in 2016. This will be wholly driven by the contribution of the passenger side of the business, with passenger revenues expected to rise to USD 533Bn in 2016 from USD 525Bn in 2015. Cargo revenues are expected to fall slightly to USD 50.8Bn from USD 52.2Bn in 2015, mainly due to a sluggish growth in international trade.
  5. 5. 5 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Weakening economies and stiff competition stifle growth of Airline business in Africa. North America Shines, Africa Lags Behind: North America will remain to be the leading industry performer, on account of a strong US economy, an appreciating US dollar, lower oil prices and a restructured industry. N. America is expected to generate more than half of the industry’s total profits in 2016, with a projection of USD 19.2Bn. The Middle East carriers are however expected to post varied trends in 2016. Gulf airlines will continue posting sturdy growth due to their successful long-haul super connector operations, whilst the regionally focussed airlines may continue suffering from the impact of lower oil prices and political conflict. Closer to-home, we expect African airlines to remain in the red in 2016, but trim down on their losses from USD 300Mn to USD 100Mn. Political instability is impacting important tourism markets in North Africa, while weakening economies and stiff competition from international economies will tend to stifle growth in the airline industry. We expect these effects to trickle down to our national carrier with slower growth anticipated in the long run. GLOBAL PERFORMANCE HIGHLIGHTS:
  6. 6. 6 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Source: IATA, ICAO Source: IATA, ICAO Source: IATA, ICAO Sturdy Profit Growth for Aviation… The airline industry had another strong year in 2014, solidifying a positive trend in profitability after huge losses during the 2008-2009 global economic recession. Net profit margins in 2014 stood at 2.2%, building on the previous years’ margins of 1.5%. The industry’s profitability was mainly underpinned by improving global economic conditions as a result of robust growth in passenger and air cargo demand. Furthered by Lower fuel costs also helped, however airlines were yet to experience the benefits of the decline in fuel prices; due to hedging. Looking ahead, the financial performance of non-US carriers could be hampered by the strong appreciation of the US dollar, which adversely affects costs denominated in US dollars. Traffic Grew at an Accelerated Rate for some Routes while others lagged… RPKs between regions of the worlds expanded by 6.1%, compared to 5.4% in 2013. The growth trend was a reflection of the increased demand that resulted from improvements in the global economy. RPKs between the Middle East and North America accelerated strongly, while those for Central and South America and within Asia, witnessed a slowdown. South America was fraught by the reduced capacity to Venezuela because of the challenges in repatriating their funds held by the country’s government while Asian markets faced notable declines in international travel to Thailand and Malaysia. Africa also posted dwindled RPK and ASK growth overall. FTKs Resurge, RPKs Post Slower Growth, Robust Margins… Demand for cargo and passenger services, measured in freight tonne kilometres (FTKs) and in revenue passenger kilometres (RPKs) accelerated in 2014, albeit for RPKs was slower. An upturn in the global economy and an increase in world trade were the main triggers for the growth. Greatest improvement was in mature economies, such as USA and UK, but some emerging countries like India and China posted faster growth rates. GDP growth has a larger impact on the air transport demand, as each unit of GDP generates more air travel in emerging economies than in mature markets. Enriched Return on Invested Capital … Overall, the return on invested capital in the industry rose from 4.9% in 2013 to 6.1% in 2014. This is short of investors’ expectations (7-8%) based on returns from investments in other sectors. The improvement in profitability and return on invested capital is however remarkable, based on the fact that this was the highest it had ever been since 2009. Biggest revenue contributor will remain to be passenger demand as freight load factors will remain low, based on alternate transport modes which are slowly eating away the cargo capacity. There is also an overall weakness in world trade growth expected to hamper progression in the cargo business.
  7. 7. 7 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Resumption of daily flights to West Africa and lifting of various travel bans to fuel growth in 2016 Plummeting oil prices fail to offer solace for Kenya Airways Cash from sale of land and aircraft expected to keep the airline afloat as it awaits the decision by the top shareholders on a possible capital injection INVESTMENT THEMES State of the African Economy: African airlines experienced the slowest annual demand growth, up 0.9% compared to 2013. The load factor was the lowest among the regions, dropping 1.5% to 67.5%. This weakness in international air travel has been translated into Kenya’s national carrier, resulting in a 2% dip in the load factor to 63.6% from 65.6% in FY14. This slump in performance is partly attributable to the Ebola outbreak, travel advisories which had been issued by various nations, slowed down economic growth in markets such as Nigeria due to decline in the oil prices (oil being their biggest export) among other factors. Following the resumption of daily flights to Liberia’s capital Monrovia in May 2015, after lifting of the government’s nine-month ban due to Ebola attacks, we expect the routes to bolster the airline’s revenues by KES 4.2Bn. African operations excluding Kenya accounted for KES 48.6Bn (54% of total passenger revenues in 2014) which was higher than the revenue contribution for FY15 (53.8%). However we anticipate the resumption of the daily flights to West African nations to fuel growth in the airline business in 2016. Introduction of direct flights to the US and lifting of various travel bans by nations such as US, France and UK is also expected to drive growth in 2016, albeit in a modest way, since the transit will be very gradual for the airline. In the run up to elections for 2017, Kenya’s political climate is also expected to contribute greatly towards the recovery of the airline and hospitality business. Bitter-Sweet Story Elicited by Fuel Volatility: Fuel prices will be the dominant feature in the airline industry economics for the better part of 2016. Threats of slackening consumer demand may cast a long shadow on carriers. The oil price outlook will prove a key source of the most important source of macroeconomic uncertainty facing the airline sector in 2016. This effect has been extremely positive for various economies as the cost savings, associated with the lower fuel prices, impacted the bottom line directly. However, this was not the case for Kenya Airways as in the full year ended March 2015, KQ reported unrealized losses worth KES 5.78Bn and realized a loss of KES 1.68Bn, a 72.43% rise from FY14. As at 31st March 2015, the group had in place fuel hedging contracts for 79% of its anticipated fuel requirements up to 31st March 2016 and 40% of anticipated fuel requirements for the period to 31st March 2017. The fuel hedge contracts are set to expire in 2017. Therefore we anticipate that the company will still report losses on their fuel derivatives at the end of this financial year 2016, due to the falling oil prices. After the expiry of the contracts, the airline is expected to position itself to benefit from the falling oil prices. Any Light at the End of the Tunnel: KQ is currently undergoing a restructuring process expected to boost its earnings by KES 20Bn. A strained liquidity position has created an impasse for the company, making it difficult for it to meet its operating expenses such as paying salaries for staff. Due to the deleterious position, the government injected KES 4.2Bn into the airline, to help it stay afloat. A long-term bailout proposal is in discussion with the top two shareholders (Government and KLM), under which they would either consider debt or equity financing. A new round of equity financing through a potential rights issue, could see the government’s ownership in KQ raised to 50% from the current 29.8%. We opine that this move would give the government the much needed control over the airline, with expectations that it will drive it back to profitability. The government could probably be borrowing a leaf from the successful Ethiopian Airlines which is state-owned. The form of recapitalisation to be employed is dependent on the instituted turnaround plan prepared by McKinsey and Seabury consultants which is still not in the public domain. The sale of a 30-acre piece of land in
  8. 8. 8 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Revenue contribution from Europe route subdues; Africa holds steady Embakasi is expected to be finalized by Q1 2016, with the transaction expected to fetch more than KES 2.2Bn. A cumulative sum of KES 14.6Bn is expected from the sale of its assets; the sale or leasing of 4 Boeing 777-200 planes and the land sale. This will help improve the cash position of the troubled airline even as they solicit for more funds. Nevertheless, we anticipate that the liquidity position will be enhanced by the fact that the airline is cutting back on its capital expenditures. As part of its fleet rationalisation programme, Kenya Airways (KQ) has entered into a sale agreement with a US-based airline, Omni International, for sale of its two Boeing 777- 200ER. The board has already approved the sale of the two planes with the funds expected to boost its liquidity position. Partnership with KLM Fails to Yield: KLM holds 26.73% equity interest in Kenya Airways Ltd, and has a joint operations agreement with Kenya Airways Ltd which commenced in November 1997. The agreement allows the two airlines to co-operate in developing schedules and fares and to share generated revenue benefits and costs for the core routes between Nairobi and Amsterdam. According to the chart below, revenue contribution from the Europe route has dwindled over the years, from 29% in FY09 to 22% in FY 15 while on the other hand the African route has remained to be the biggest contributor of revenues over the years, with FY14 registering the highest revenue contribution of 54%. This trend has elicited questions over the partnership between KLM and KQ over the years. The company is currently on deliberations with its two top shareholders on a possible capital injection. The government initially gave a KES 4.2Bn bailout package, which was insufficient to the company. We are of the opinion that the company needs to consider engaging strategic investors who could possibly inject capital to the tune of KES 60Bn into the company, whilst also cementing more valuable partnerships with other airlines that could positively impact the airline’s business in the future, post the turn-around. Source: Annual reports, Genghis Research 29% 27% 27% 26% 22% 22% 22%22% 21% 19% 19% 20% 18% 19% 45% 48% 49% 49% 52% 54% 49% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% FY09 FY10 FY11 FY12 FY13 FY14 FY15 Revenue Contribution by region %Europe %MiddleEast&Asia % Africa
  9. 9. 9 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Revenue Performance (4Years) Source: Annual reports, Genghis Research Gross Profit Performance (4Years) Source: Annual reports, Genghis Research EBITDA Performance (4Years) Source: Annual reports, Genghis Research Loss before Tax Performance (4Years) Source: Annual reports, Genghis Research KENYA AIRWAYS PERFORMANCE HIGHLIGHTS: Lull Turnover Growth, Slowed Down Cargo Revenues: Flat revenue growth was however observed on a year-on-year basis. We project the revenues for FY16 to grow by 2.3% to KES 112.75Mn. The airline recorded a capacity of 15.41Bn available seat kilometres, a y-o-y growth of 8.6%, while the revenue passenger kilometres (RPK) rose by 5.2% to 9.79Bn. This drove down the achieved cabin factor to 63.6%, from 65.6% the prior year. Capacity availed to Europe grew by 13%, mainly buoyed by the deployment of the larger B777-300ER to Amsterdam in place of the B777- 200ER, and the upgrade of the Paris operations to a B787 Dreamliner from the B767s. Africa’s capacity increased by 3.6% as a result of additional frequencies to most destinations. The capacity within the domestic market registered a 29% growth following a successful entry of their low cost carrier- Jambojet- into the arena. Kenya contributes 11% of its total revenues as the rest of the continent contributed 49% of its total revenues. Robust Gross Profit Margins: The company posted sturdy growth on the gross profits between FY13 and FY14, but the profit margin was slightly scaled down to 22.2% in FY15 from 22.3% in FY 14. This was attributable to the decline in the cost of sales, despite the flat growth on the revenues. We portend the margins to improve to 28.4% in FY16E based on 5.7% reduction in the direct costs and a 2.3% growth in revenues. To KES 112.75Bn. Operating Losses Surged by 500.3%: The operating loss rose by 500.3% y-o-y to KES 16.33Bn driven by the 107.6% surge in fleet ownership costs to KES 25.93Bn and 16.8% increase in overheads to KES 24.50Bn. Under fleet ownership costs, KES 7Bn was accrued from the impairment and other costs associated with the retirement of the old fleet. Trimmed Growth on Losses before Taxes: The profit margins were wiped out by a 186% rise in financing costs to KES 4.58Bn and an accelerated depreciation and amortisation in the period under review. We anticipate that loss before taxes will improve slightly to KES 19.08Bn, cutting down on the losses based on the assumption that there will be no impairments or other adjustments. The three- year CAGR stands at -3.6%. Capital and Reserves Stripped off: For the first time in history, Kenya Airways reported a negative equity position, indicative that the carrier had exhausted its retained earnings and cash flow hedging reserves. KQ’s negative equity position stood at KES -5.96Bn in the full year to March 2015, from KES 28.23Bn in March 2014. The condition worsened in September 2015, as the total equity stood at KES -33.86Bn. It’s quite clear that KQ may not be in a position to reverse its current state soon even if it was to grow its revenues by 10% in the next 3 years. Thus, there is a dire need for capital injection by the shareholders to reverse the equity position. 98,860 106,009 110,161 112,749 7.2% 3.9% 2.3% 0.02 0.03 0.04 0.05 0.06 0.07 0.08 90,000 95,000 100,000 105,000 110,000 115,000 FY13A FY14A FY15A FY16E Growthtrend Revenues Revenues y-o-y growth 60.4% 3.6% 30.7% 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 10,000 15,000 20,000 25,000 30,000 35,000 FY13A FY14A FY15A FY16E GrowthTrend GrossProfit Gross Profit Y-O-Y growth -2,457 4,199 1,356 5,399 70.9% -67.7% 298.1% -1 -1 0 1 1 2 2 3 3 4 -3,000 -2,000 -1,000 0 1,000 2,000 3,000 4,000 5,000 6,000 FY13A FY14A FY15A FY16E Y-O-YGrowth EBITDA EBITDA Y-O-Y growth -21,312 -11,323 -29,712 -19,075 46.9% 162.4% 35.8% 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 -35,000 -30,000 -25,000 -20,000 -15,000 -10,000 -5,000 0 FY13A FY14A FY15A FY16E GrowthTrend LossBeforeTax Loss Before Tax Y-O-Y growth
  10. 10. 10 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Net Income Performance (4 Years) Source: Annual reports, Genghis Research Cash Conversion Cycle/Operating Cycle Source: Bloomberg, Genghis Research Breakeven Load factor vs Load factor Source: Bloomberg, Genghis Research Record-Setting Loss Shakes its Wings: High finance costs, depreciation of shilling, realized and unrealized fuel hedge losses and loan revaluation losses adversely affected the airline’s profitability, causing a 161.5% growth in net losses to KES 25.74Bn (FY15). This was the worst performance that KQ had ever posted. Following the implementation of the turn- around plan in November 2015, we anticipate a slight improvement in the carrier. Our projections for loss after tax for FY16E is KES 19.08Bn, a 25.9% improvement from the previous performance assuming the carrier will receive a tax credit. Taut Working Capital Cycles: From the illustration on the left, it’s clear that the company took a shorter time span to offset its creditors’ dues between FY07 and FY08. Between FY09 and FY10 the time increased and then stagnated. The company is facing a stagnated operating cycle due to reduced passenger and cargo demand which form their biggest debtors. Far from Breaking Even on the Load Factors: Based on our analysis, KQ is far from breaking even on its load factors based on the poor growth in revenue. This could be mainly attributed to sluggish growth on passenger and cargo revenues as a result of low demand. -18,350 -9,844 -25,743 -19,075 46.4% 161.5% 25.9% 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 -30,000 -25,000 -20,000 -15,000 -10,000 -5,000 0 FY13A FY14A FY15A FY16E GrowthTrend NetIncome Net Income Y-O-Y growth -60.00 -50.00 -40.00 -30.00 -20.00 -10.00 0.00 10.00 20.00 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 90.00 100.00 FY 05 FY 06 FY 07 FY 08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Operating cycle Cash Conversion Cycle 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 90.00 100.00 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Break-Even Load Factor Load Factor
  11. 11. 11 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Poor Corporate governance hurts KQ Operational inefficiencies remains a thorn in the flesh RISKS TO INVESMENT CALL: Is Corporate Governance a Miss in the Airline? Mismanagement accusations have been made against the former CEO Titus Naikuni among other company executives by the senate committee, concerning the stalemate in Kenya Airways. A chain of decisions made in the top level have negatively impacted KQ’s performance, leaving it down on its knees. A parliamentary report issued towards the end of 2015, questioned the capability of Kenya Airway’s Chief Executive Officer, Mbuvi Igunze and the company’s board to run the national carrier. It was indicated that a majority of the executives had a deficiency of the skills required to run a company in the aviation industry, leaving the firm at a risk of mismanagement and poor decision making. Among the recommendations made by the senate, was the need to hire a new marketing director with proven international experience to fix its ticketing system and ensure proper accounting of revenue. A reconstitution of the board of directors was also recommended. On 11th November 2015, Ambassador Dennis Awori was elected chairman of the Board of Kenya Airways Ltd to replace the retired Mr. Evanson Mwaniki. Group Financial director, Mr. Alex Mbugua is the latest to be sent packing, as part of the broader initiative to turn around the fortunes of the loss-making company. Mr. Dick Murianki will replace Mr. Mbugua in an acting capacity until the position is filled up. Rick Sine, the company’s fleet director also left with no clear reasons cited as to his exit. This is a milestone as the airline strives to regain its altitude as the “Pride of Africa.” Good corporate culture is what will run the organization profitably over the long haul. Progressively, other changes have been made to the top management team, partly responding to demands by the senate but the same is yet to yield fruit. Operational Inefficiencies a Common Issue: Escalating operating costs have led to trimmed margins, with the cost of leasing aircrafts and outsourcing services, highlighted as the main detriment. High operating costs was one of the causes of the record-setting slump in profitability. This resulted in poor financial performance and declining profitability. The airline showed signs of recovery in the year to September 2015, with a significant reduction of 79.2% in the operational losses.
  12. 12. 12 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com KQ grapples with competition from budget carriers and other Middle East and African carriers Unattractive ticket pricing drags revenues down Competitive Rivalry; a Big Threat to Kenya Airways: Kenya Airways continues to face competition from regional carriers such as Ethiopian Airlines and South African Airways. In the financial year ended June 2015, Ethiopian Airlines posted a net profit of KES 17.8Bn (USD 175Mn) in comparison to the KES 25Bn loss posted in March 2015 by its counterpart Kenya Airways Ltd. The airline had ferried 6.4Mn passengers last year, against 4.2Mn passengers ferried by KQ; indicative of high competition forces emanating regionally, from Middle East carriers (Emirates, Qatar Airways) among others. State backed Ethiopian airlines introduced flights to Cameroon’s capital Yaoundé, raising the competition bar. Ethiopia airlines is set to buy 10 narrow body planes. In addition, the airline is considering Canada’s Bombardier and Brazil’s Embraer. Plans are underway to double its fleet between now and 2025 and they expect to grow from 77 aircraft and 7.4Mn passengers this year to 22Mn passengers and 150 aircrafts by 2025. Rwanda air on the other hand, has partnered with Ecobank, VisaRwanda and Global travel wallet with a goal of increasing passengers from 500,000 annually to more than 3Mn by 2020. Ecobank will power flexible and convenient payment solutions to all travellers on the Rwanda Air fleet offering them customer centric services. Competition threats are also stemming from budget carriers too, exposing Kenya Airways to the risk of reduced market share if action is not taken. Fastjet launched flights from Dar es Salaam and Kilimanjaro to JKIA with plans underway to introduce flights between Dar es Salaam and Mombasa & Zanzibar and Nairobi flights by the end of the year. Implementation of the open skies policy is set to allow more airlines on the coastal route, thus we anticipate KQ to face heightened competition as it tries to grapple with charter flights from foreign countries. Furthermore, connection routes have also enhanced competition for the national carrier, with some passengers opting for a much longer long haul flight rather than a more expensive shorter flight time. Routes such as Zambia and South Africa have experienced enhanced competition from Rwanda Air and Fastjet respectively. Unattractive Ticket Pricing Drags Revenues Down: The expensive ticketing system has resulted in Kenya Airways having non- competitive tickets in the market thus leading to loss of business to competitors. Ticket pricing needs to be competitive to attract more customers to use your airline. KQ needs to consider offering competitive discounts to conference delegates, as well as give good rates off the peak season to boost customers’ appetite and compete effectively with other carriers.
  13. 13. 13 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Job cuts and fleet reorganisation expected to reduce cost Right size fleet utilization to ensure capacity optimization. Better pricing mechanisms Improved route profitability Sale of assets expected to boost cash flows Could a tax holiday for ailing KQ offer respite? ROAD MAP TO KQ’S SUCCESS… Kenya Airways (KQ) will be hoping to calm headwinds that pummelled its business as it seeks to rebound from record losses and turn around their negative equity position. Mc Kinsey Consultants and Seabury Consultants were tasked to come up with a turnaround plan that will drive Kenya Airways back to profitability. Twenty four strategies are being implemented over a period of 1.5years with savings of around USD 300Mn expected. Below are the key focus areas for the carrier: Cost Reduction- The national carrier signalled a new round of job cuts, barely three years after it let go more than 500 employees in a retrenchment exercise that was meant to reduce its costs and help revive its flagging fortunes. The fresh look at its staffing will be to help them match their business model to reduce costs. Operation of only one type of aircraft (or minimal number of aircrafts) will help minimize the size of spare parts inventories, simplify the training of maintenance and repair personnel, thus improving the proficiency and speed with which maintenance routines are done. Revenue Management (RM) - the airline is looking into managing their revenue more efficiently through sales effectiveness and market management. Right size fleet utilization will also ensure that they are optimizing their capacities on the routes where they operate. Infusion of Technology into Pricing and Productivity Improvement- Digitalizing reservations and purchase of tickets will help in reducing the cost of pricing the tickets. The cost of pricing the tickets is usually higher due to the other direct costs that have to be factored in their pricing mechanisms such as commissions. This will also help in reducing the commissions to travel agents which thin out the operating margins. Riding on the Tag Line “Pride of Africa” to Improve Route Profitability- Kenya Airways stands a chance to benefit from an African-focussed route strategy. Around half of their revenues is generated on African routes, thus giving it a competitive edge in the markets they are already in operation. Reduced political instability will also be key in bolstering the firms’ profitability. KQ also needs to add flights where rivals are cutting back their service in order to counter the competition from other airlines. Cash and Financial Optimization- This will be driven through the planned sale of assets (both land and aircraft) expected to raise KES 14.6Bn, restructuring of their short-term loans through conversion of short-term debt obligations of USD 250Mn into long-term debt with tenures of about 7 years. (Long-term loans stand at USD 1.14Mn and short term debt stands at USD 517.8Mn). In October 2015, the loss making airline drew down a KES 10Bn (USD 100Mn) bridging loan from Afrexim bank which was expected to take care of the short term liabilities, as it worked on attaining a firmer financial footing. Tax Holidays for KQ- This was recommended by the senate committee while investigating on the downfall of the airline. The National Treasury should consider initiating the process of providing a favourable tax regime, as its success will be better achieved through the creation of Nairobi aviation hub.
  14. 14. 14 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Kenya Airways Ltd Du-pont Analysis-ROE Decomposition Source: Annual reports, Genghis Research From our three-step du-pont analysis, Kenya Airway’s net profit margin has deteriorated from -3.2% to -23.4%, indicating that the company has been generating lower profits from the revenues. This could be driven by the rising financing costs and unrealized and realized losses from their fuel hedging contracts. On the other hand, the company’s efficiency on asset utilization has also been on a downward spiral, indicating that minimal or no value has been derived from the fleet modernisation programme. Over the last one year, the company has more than doubled its gearing; the equity multiplier stands at 14.85x in 2015 against 4.57x in 2014. This creates a high risk for the firm, as the company is over-leveraged making it a bad sign. The ROE has declined to -231.23% (FY15) from -11.38% (FY14), pointing out to a negative signal as the company is drastically wiping out the shareholders’ value on the stock. The company is barely generating anything for its shareholders, a situation that could have been accentuated by the negative equity position in their last financials. A decline in the net profit margin and the asset turnover, and an increase in leverage, poses as a deleterious position for the national carrier. Financial Statement data (KES Millions) FY13 FY14 FY15 Sales 98,860 106,009 110,161 EBT -10,826 -4,861 -29,712 EBIT -11,312 -6,462 -34,293 Interest Expense -1,907 -2,424 -4,734 Tax Expense 2,962 1,479 3,969 Net Income -7,864 -3,382 -25,743 Total Assets 122,696 148,657 182,063 Total Equity 31,209 28,229 -5,963 Three-Step Dupont Model: Net Profit Margin (Net Income/Sales) -8.0% -3.2% -23.4% Asset Turnover(Sales/Average Assets) 0.81 0.78 0.67 Equity Multiplier (Average Assets/Average Equity) 3.93 4.57 14.85 Return on Equity -0.25 -0.11 -2.31 Five-Step Dupont Model: Tax Burden (Net Income/EBT) 0.73 0.70 0.87 Interest Burden(EBT/EBIT) 0.96 0.75 0.87 Operating Income Margin (EBIT/Sales) -11.4% -6.1% -31.1% Asset Turnover (Sales/Average Assets) 0.81 0.78 0.67 Equity Multiplier (Average Assets/Average Equity) 3.93 4.57 14.85 Return on Equity -25.20% -11.38% -231.23% Kenya Airways ROE Decomposition FY13A FY14A FY15A Net income/ Equity -25.20% -11.38% -231.23% Tax Burden 0.73x 0.70x 0.87x Interest Burden 0.96x 0.75x 0.87x Operating Margin -11.44% -6.10% -31.13% Asset Turnover 0.81x 0.78x 0.67x Financial Leverage 3.93x 4.57x 14.85x -25.20% -11.38% -231.23%
  15. 15. 15 | P a g e EQUITY RESEARCH Bloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Kenya Airways Ltd Altman’s Z-Score- Testing for Bankruptcy Source: Annual reports, Genghis Research Test Scores: We used the Altman’s Z-score to determine how likely the company could fail or go bankrupt and from our empirical results, Kenya Airways Ltd gave signs of going bankrupt from 2013, when the coefficient of the Z-score went below 1.88. In 2015, the carrier was close to being declared bankrupt, with a Z-score coefficient of - 0.06. Working Capital/Total Assets: From our empirical results, the first ratio, working capital/total assets, and the decline from -0.18 x to -0.23x, indicates that the firms’ position to pay its creditors in the short term had been worsening, but slightly improved in FY15 to -0.22. Retained Earnings/Total Assets: Retained earnings/total assets ratio has degenerated from 0.11x (FY13) to 0.07x (FY14), then fell in the red (-0.09x) in FY15. The company’s profitability has ebbed overtime, as the retained earnings continue to be wiped out. In 2015, the company eroded its retained earnings, leaving it with a negative position of KES 15.68Bn. This position could however be reversed, if the airline gets a capital injection. EBIT/Total Assets: The company assets’ efficiency to generate extra profits has been on a decline from -0.02x (FY14) t0 -0.09x (FY15). This is worrying especially coming at a time when the airline has been growing their asset base, for instance their aircraft. Despite the huge fleet, of concern could be their capacity utilization to generate earnings. Market Value of Equity/ Total Liabilities: This is a fluid measure used to test the market’s (both lenders and shareholders) confidence in the company. The ratio indicated a significant decline from 0.21x in FY13 to 0.11x in FY14 and a further weakening to 0.04x in FY15. Is KQ still a Viable Investment Decision? Based on the indicators used, Kenya Airways Ltd is currently on the brink of being declared bankrupt. Investors should therefore exercise caution while trading in this shares. However, the possibilities of a bailout from the two top shareholders; the government and KLM could offer solace to the company. PARAMETERS(KESMillions) FY13 FY14 FY15 IncomeStatement NetSales 98,860 106,009 110,161 OperatingIncome/loss (9,012) (2,721) (16,333) BalanceSheet CurrentAssets 28,608 29,636 41,052 TotalAssets 122,696 148,657 182,063 CurrentLiabilities 50,841 63,756 81,753 TotalLiabilities 91,487 120,428 188,026 RetainedEarnings 13,441 10,070 (15,676) Publiccompanies Marketvalueofequity 19,528 13,019 7,183 CALCULATIONS FY13 FY14 FY15 Coefficient Workingcapital/Totalassets -0.18 -0.23 -0.22 1.2 Retainedearning/Totalassets 0.11 0.07 -0.09 1.4 EBIT/Totalassets -0.07 -0.02 -0.09 3.3 Marketvalueofequity/Total liabilities 0.21 0.11 0.04 0.6 Netsales/Totalassets 0.81 0.71 0.61 1.0 Z-Score 0.63 0.54 -0.06 Coefficient LEGEND Remarks Financiallysoundifgreaterthan 2.99 Χ Cautionrequiredifbetween 2.77-2.99 Χ Likelytogobankruptwithin2yearsifbetween 1.8-2.7 Χ Likelihoodofbankruptcyishighifbelow 1.88 √ Averagefornonbankruptcompanies 5.02 Χ Averageforbankruptcompanies -0.29 √
  16. 16. 16 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Kenya Airways Ltd Beneish M-Score- Testing for Earnings Manipulation We used Beneish M-score to test for any probabilities of earnings manipulation by the national carrier. The following analysis gives an explanation of the empirical results observed: Days Sales in Receivables Index: The index improved marginally to 1.040 from 1.227, thus we drew our conclusion that the firm has not inflated their revenues. Gross Margin Index: The index weakened to 0.989 from 0.960, the previous year. Kenya Airway’s margins are close to deterioration since the index is close to surpassing the 1.0 threshold. Asset Quality Index: the company’s asset quality depreciated from 1.119 to 0.416. A decline in the value of intangible assets, prepaid operating lease rentals, aircraft deposits and an increase in the deferred tax assets contributed to the waning of the asset quality index. Depreciation Index: Kenya Airways could be revising the useful life of its non-current assets upwards, or adopting a new method that is income friendly to compute for the depreciation of its assets. A rise in the DEPI indicates that the assets are being depreciated at a higher than normal rate. Sales, General and Administrative Expenses Index: There is a disproportionate increase in the selling, general and administrative expenses in comparison to the net sales. This is a negative signal to the firm’s future prospects. Leverage Index: This index rose to 1.333 in FY15 from 1.143 in FY14, illustrating a surge in the gearing applied in Kenya Airways over the last one year. We opine that the carrier posted their debt position free of liability, based on the fact that they have been heavily focussed on borrowing to meet their working capital liabilities. Total Accruals to Total Assets Index: This index was used to gauge the firm’s extent to which the managers make discretionary accounting policies to alter their earnings. From the Beneish M-score analysis, we concluded it was likely that the firm may have been engaging in creative accounting techniques, both in 2014 and 2015, as its M>-2.22. Using the 5- variable equation, we arrived at -3.17 and by using the 8-variable equation, we arrived at -3.55. Both values are greater than -2.22, thus a high likelihood of earnings manipulation. The main line item that could be significantly vulnerable is depreciation, as it had the highest variance of 30.3% among all the parameters used. Source: Annual reports, Genghis Research Parameters in KES Millions FY13 FY14 FY15 Net Sales 98,860 106,009 110,161 Direct costs -77,225 -75,268 -76,059 Net Receivables 10,413 13,706 14,819 Current Assets 28,608 29,636 41,052 Property, Plant and Equipment 71,502 88,389 125,422 Depreciation 4,080 5,350 10,704 Total Assets 122,696 148,657 182,063 SGA Expense 18,643 20,972 24,503 Net Income -7,864 -3,382 -25,743 Cash Flow from Operations 334 4,532 5,904 Current Liabilities 50,841 63,756 81,753 Long-term Debt 31,421 50,120 104,175 Derived Variables Other L/T Assets [TA-(CA+PPE)] 22,586 30,632 15,589 DSRI 1.227 1.040 GMI 0.960 0.989 AQI 1.119 0.416 SGI 1.072 1.039 DEPI 1.057 1.378 SGAI 1.049 1.124 TATA -0.067 -0.053 -0.174 LVGI 1.143 1.333 M-score 5 variable model -2.64 -3.17 8 variable model -2.48 -3.55 Glossary CA Current Assets DSRI Days Sales in Receivables Index GMI Gross Margin Index AQI Asset Quality Index SGI Sales Growth Index DEPI Depreciation Index SGAI Sales, General and Administrative Expenses Index LVGI Leverage Index TATA Total Accruals to Total Assets
  17. 17. 17 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Kenya Airways Ltd Piotroski F-Score Testing for Strength of Firm’s Financial Position Source: Annual reports, Genghis Research We conducted this test to evaluate the firm’s financial strength. Piotroski’s F-score encompasses nine variables from a company’s financial statements. The empirical results obtained indicate that Kenya Airways has an average strength on its financial position for both 2014 and 2015. The test was however carried out on the assumption that the firm does not employ any accounting malpractices while preparing the financial statements. Below is a summary of the results obtained: Profitability Signals:  KQ scored nil on net income for both years as it has been in the loss category.  Positive operating cash flows scored KQ one point in both years.  The ROA for 2014 was higher than that for 2013, but fell in 2015 giving it a zero score.  KQ scored 1 on both years for the quality of earnings as the cash flow from operations exceeded the net income before extraordinary items. Leverage, liquidity and source of funds:  There was an increase in the leverage for both years, thus a score of 0.  An increase in liquidity for 2015, tested by the current ratio, gave it a score of 1.  Impressively, there was no dilution as the firm didn’t issue any new shares/equity in the preceding year, scoring it 1. Operating Efficiency:  We scored 1 for both years as there was a higher gross margin compared to the previous years.  We scored 0 as the asset turnover ratio Y-o-Y was lower. PARAMETERS in KES Millions FY13 FY14 FY15 Net Income (7,864) (3,382) (25,743) Total Assets 122,696 148,657 182,063 ROA -6.4% -2.3% -14.1% Cash from Operations (537) 2,738 1,214 LT Debt 31,421 50,120 104,175 LT Debt/Total Assets 25.6% 33.7% 57.2% Current Assets 28,608 29,636 41,052 Current Liabilities 50,841 63,756 81,753 Current Ratio 0.56 0.46 0.50 Net Income From Total Operations (7,864) (3,382) (25,743) Fully Diluted EPS 6.35 (2.25) (17.21) Shares outstanding 1,496 1,496 1,496 Revenues 98,860 106,009 110,161 Gross Income 21,635 30,741 34,102 Gross Margin 21.9% 29.0% 31.0% Asset Turnover 0.81 0.71 0.61 Piotroski Calculation FY14 FY15 Piotroski 1: Net Income 0 0 Piotroski 2: Operating Cash Flow 1 1 Piotroski 3: Return on Assets 1 0 Piotroski 4: Quality of Earnings 1 1 Piotroski 5: LT Debt vs Assets 0 0 Piotroski 6: Current Ratio 0 1 Piotroski 7: Shares Outstanding 1 1 Piotroski 8: Gross Margin 1 1 Piotroski 9: Asset Turnover 0 0 Piotroski F Score 5 5 KQ has an average strength on its financial position
  18. 18. 18 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Source: Annual Reports, Genghis Research Kenya Airways Limited Ratio Analysis Year End- 31st March Year End -31st March - KES (Mns) FY13A FY14A FY15A FY16E FY17F FY18F FY19F FY20F Number of shares 1,496 1,496 1,496 1,496 1,496 1,496 1,496 1,496 Managers Viewpoint Gross profit margin 14.9% 22.3% 22.2% 28.4% 33.4% 38.3% 43.0% 47.8% EBITDA margin -2.5% 4.0% 1.2% 4.8% 8.6% 12.4% 17.1% 21.9% EBIT margin -8.3% -2.6% -9.8% -10.7% -6.2% -1.5% 4.3% 10.2% Return on assets (ROA) -15.0% -6.6% -14.1% -10.6% -8.5% -6.5% -3.4% 0.1% Fixed assets turnover 1.05 0.89 0.78 0.72 0.70 0.69 0.69 0.70 Total assets turnover 0.81 0.71 0.61 0.63 0.62 0.61 0.62 0.62 Net income margin -18.6% -9.3% -23.4% -16.9% -13.7% -10.6% -5.5% 0.2% Free cash flow yield 0.0% 0.0% 0.0% -137.6% -129.2% -134.7% -61.9% -41.4% Total assets growth 21.16% 22.47% -1.54% 11.27% 11.79% 13.26% 14.34% Owners/ Investors Viewpoint Earnings/ (loss) per share 6.35 (2.25) (17.21) (12.75) (11.30) (9.62) (5.75) 0.19 Dividends per share - - - - - - - - Return on equity (ROE) -58.9% -34.9% 428.4% 76.0% 40.3% 25.5% 13.2% -0.4% Price to earnings (P/E) 2.06x -3.87x -0.28x -0.24x -1.20x -1.22x -3.60x 114.76x Price to book value (P/B) 0.63x 0.46x -1.22x -0.18x -0.48x -0.31x -0.48x -0.50x Lenders Viewpoint Current ratio 1.41x 1.19x 1.08x 0.52x 0.53x 0.54x 0.56x 0.57x Quick ratio 1.28x 1.09x 1.03x 0.47x 0.48x 0.50x 0.51x 0.53x Cash Ratio 0.71x 0.45x 0.09x 0.05x 0.05x 0.04x 0.04x 0.04x Operating Cash Flow/Current Liabilities -0.01x 0.04x 0.01x 0.07x 0.03x 0.10x 0.25x 0.41x Operating Cash Flow/Sales -0.01x 0.03x 0.01x 0.03x 0.01x 0.04x 0.08x 0.12x Operating Cash Flow/Total Liabilities -0.01x 0.02x 0.01x 0.01x 0.01x 0.02x 0.04x 0.06x Debt-Asset ratio 0.51x 0.60x 0.81x 0.89x 0.98x 1.04x 1.05x 1.03x Debt-Capitalization ratio 1.99x 3.16x -24.59x -6.37x -4.65x -4.10x -4.09x -4.59x Efficiency Inventory Turnover 33.23x 33.47x 45.16x 40.56x 40.56x 40.56x 40.56x 40.56x Receivables Turnover 9.49x 7.73x 7.43x 7.77x 7.77x 7.77x 7.77x 7.77x Payables Turnover 8.12x 6.78x 4.70x 4.06x 4.06x 4.06x 4.06x 4.06x Working Capital Turnover 11.90x 22.21x 37.88x -5.50x -5.94x -6.45x -7.07x -7.80x Per share data EPS 6.35 (2.25) (17.21) (12.75) (11.30) (9.62) (5.75) 0.19 DPS - - - - - - - - BVPS 20.83 18.84 (4.02) (16.77) (28.07) (37.69) (43.44) (43.29) Sales per share 66.08 70.86 73.64 75.37 82.31 90.71 104.03 120.34 Valuation Multiples EV/EBITDA(x) -27.33x 21.64x 112.02x 30.07x 20.27x 14.66x 11.10x 8.31x EV/Sales(x) 0.68x 0.86x 1.38x 1.44x 1.73x 1.82x 1.89x 1.82x P/E(X) 2.06x -3.87x -0.28x -0.24x -1.20x -1.22x -3.60x 114.76x P/BV(X) 0.63x 0.46x -1.22x -0.18x -0.48x -0.31x -0.48x -0.50x Price to Sales 0.20x 0.12x 0.07x 0.04x 0.16x 0.13x 0.20x 0.18x
  19. 19. 19 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Kenya Airways Ltd Half Year Analysis Year end- September 30th Source: Annual Reports, Genghis Research Financial Highlights:  Flat revenue performance with capacity down 7.9%. Number of passengers ferried grew by 2.0% but didn’t translate to passenger revenue growth. Cargo revenues were further impacted by lower yields from the ban on khat into Europe, a high cargo yield commodity.  Operating loss improved by 79.2% to KES 2.2Bn from KES 10.5Bn, driven by a drop in direct operating and fleet costs. The rationalisation of operations coupled with the respite in fuels, triggered the reduction.  Loss before income tax improved by 5.1% to KES 11.9Bn, despite a 104.1% surge in finance costs and a realized loss of KES 1.3Bn on fuel derivatives.  Net loss for the period stood at KES 12.0Bn, which incorporated a one off restructuring adjustment of KES 4Bn. Income Statement for the half year ended September 30th in Mns HY12 HY13 Var HY14 Var HY15 Var Revenue 49,832.0 54,338.0 9.0% 56,788.0 4.5% 56,720.0 -0.1% Direct Operating costs (39,877.0) (37,265.0) 6.6% (42,171.0) 13.2% (34,794.0) 17.5% Fleet ownership costs (5,345.0) (5,954.0) -11.4% (13,164.0) 121.1% (13,143.0) 0.2% Overheads (10,143.0) (9,380.0) 7.5% (11,908.0) 27.0% (10,959.0) 8.0% Total Operating costs (55,365.0) (52,599.0) 5.0% (67,243.0) 27.8% (58,896.0) 12.4% Operating loss (5,533.0) 1,739.0 131.4% (10,455.0) -701.2% (2,176.0) 79.2% Operating Margin -11.1% 3.2% -18.4% -3.8% Finance costs (959.0) (1,214.0) 26.6% (1,703.0) 40.3% (3,476.0) 104.1% Finance Income 733.0 488.0 -33.4% 148.0 -69.7% 5.0 -96.6% Realised gain/ (loss) on fuel derivatives (85.0) 216.0 154.1% 681.0 215.3% (1,312.0) -292.7% Other costs (744.0) (681.0) 8.5% (1,170.0) 71.8% (4,897.0) 318.5% Loss before income tax (6,588.0) 548.0 -108.3% (12,499.0) -2380.8% (11,856.0) 5.1% Income tax (expense)/credit 1,801.0 (164.0) -109.1% 2,048.0 1148.8% (96.0) -104.7% Loss after tax (4,787.0) 384.0 (10,451.0) (11,952.0) Net profit margin (%) -9.6% 0.7% -18.4% -21.1% Loss per share (4.85) 0.26 1.1% (7.99) -11819.5% (6.99) 12.5% Profit/ (loss) for the period (4,788.0) 384.0 0.0% (10,451.0) -7.1% (11,952.0) 0.0% Balance Sheet for the half year ended September 30th in Mns HY12 HY13 Var HY14 Var HY15 Var Non -Current Assets 94,062.0 106,597.0 13.3% 158,392.0 48.6% 135,267.0 -14.6% Current Assets 28,608.0 30,328.0 6.0% 24,961.0 -17.7% 40,772.0 63.3% Total Assets 122,670.0 136,925.0 11.6% 183,353.0 33.9% 176,039.0 -4.0% Equity and Liabilities Equity attributable to owners 31,155.0 31,291.0 0.4% 14,976.0 -52.1% (33,909.0) -326.4% Non-controlling interests 54.0 50.0 -7.4% 41.0 -18.0% 48.0 17.1% Total equity 31,209.0 31,341.0 0.4% 15,017.0 -52.1% (33,861.0) -325.5% Non-current liabilities 40,620.0 47,478.0 16.9% 98,341.0 107.1% 118,565.0 20.6% Current Liabilities 50,841.0 58,106.0 14.3% 69,995.0 20.5% 91,335.0 30.5% Total liabilities 91,461.0 105,584.0 15.4% 168,336.0 59.4% 209,900.0 24.7% Total equity and liabilities 122,670.0 136,925.0 11.6% 183,353.0 33.9% 176,039.0 -4.0% Cashflow Statement for the half year ended September 30th in Millions HY12 HY13 Var HY14 Var HY15 Var Cash flows from operating activities Cash generated from operations 252.0 5,186.0 1957.9% (610.0) -111.8% 4,606.0 855.1% Interest received 733.0 488.0 -33.4% 148.0 -69.7% 5.0 -96.6% Interest paid (602.0) (1,214.0) 101.7% (1,703.0) 40.3% (3,476.0) 104.1% Income tax paid (155.0) (78.0) 49.7% (41.0) 47.4% (97.0) 136.6% Net cash generated from operating activities 228.0 4,382.0 1821.9% (2,206.0) -150.3% 1,038.0 147.1% Cash flows from investing activities Purchase of property and equipment (6,544.0) (6,484.0) 0.9% (62,642.0) 866.1% (478.0) -99.2% Proceeds from disposal of property and equipment 8.0 25.0 212.5% 0.0 -100.0% 538.0 Purchase of intangible assets 0.0 0.0 (32.0) 0.0 -100.0% Deposits paid for aircraft purchases (6,513.0) (9,631.0) 47.9% 0.0 -100.0% 0.0 Aircraft deposits refunds received 50.0 0.0 -100.0% 14,591.0 420.0 -97.1% Delayed settlement compensation 0.0 0.0 2,506.0 0.0 -100.0% Deferred expenditure (85.0) (1.0) -98.8% (1,098.0) 109700.0% (366.0) 66.7% Net cash used in investing activities (13,084.0) (16,091.0) 23.0% (46,675.0) 190.1% 114.0 100.2% Cash flows from financing activities Borrowings received 8,623 16,761.0 94.4% 64,105.0 282.5% 14,423.0 -77.5% Repayments of borrowings (2,436.0) (6,200.0) 154.5% (21,070.0) 239.8% (11,375.0) 46.0% Repayment of finance lease obligations (100.0) (105.0) 5.0% (861.0) 720.0% 0.0 -100.0% Net cash generated from financing activities 19,890.0 10,456.0 -47.4% 42,174.0 303.3% 3,048.0 -92.8% Net Increase/ (Decrease) in cash and cash equivalents 7,034.0 (1,253.0) -117.8% (6,707.0) 435.3% 4,200.0 162.6% Cash and cash equivalents at beginning of period 6,840.0 14,393.0 110.4% 11,218.0 -22.1% 3,267.0 -70.9% Cash and cash equivalents at end of period 13874 13,140.0 -5.3% 4,511.0 -65.7% 7,467.0 65.5%
  20. 20. 20 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Source: Annual Reports, Genghis Research Kenya Airways Limited Summary Financials Year End- 31st March KES in Millions, unless stated otherwise FY13A FY14A FY15A FY16E FY17F FY18F FY19F FY20F Income Statement Revenue 98,860 106,009 110,161 112,749 123,136 135,702 155,626 180,024 Cost of Sales 84,128 82,375 85,678 80,754 82,015 83,698 88,632 94,036 Gross Profit 14,732 23,634 24,483 31,995 41,121 52,004 66,995 85,989 Selling, General& Admin Expenses 17,189 19,435 23,127 26,596 30,585 35,173 40,449 46,517 EBITDA (2,457) 4,199 1,356 5,399 10,536 16,831 26,545 39,472 Depreciation and Amortisation 5,729 6,920 12,106 17,517 18,115 18,860 19,816 21,062 EBIT (8,186) (2,721) (10,750) (12,119) (7,580) (2,030) 6,729 18,410 Net Finance Costs 486 1,601 4,581 6,956 9,328 12,368 15,331 18,127 Profits Before Tax (PBT) (21,312) (11,323) (29,712) (19,075) (16,908) (14,398) (8,602) 283 Profits after Tax (PAT) (18,350) (9,844) (25,743) (19,075) (16,908) (14,398) (8,602) 283 Balance Sheet Inventories 2,532 2,461 1,897 1,991 2,022 2,064 2,185 2,319 Accounts Receivables 10,413 13,706 14,819 14,518 15,856 17,474 20,040 23,181 Cash 14,393 11,218 3,267 2,000 2,000 2,000 2,000 2,000 Other Current Assets 1,270 2,251 21,069 3,426 3,426 3,426 3,426 3,426 Total Current Assets 28,608 29,636 41,052 21,936 23,304 24,964 27,651 30,926 Property Plant and Equipment 71,502 88,389 125,422 141,322 159,599 180,707 206,577 238,171 Intangibles 2,029 1,619 1,163 1,570 2,120 2,861 3,863 5,215 Airport Deposits 19,095 27,505 10,391 10,391 10,391 10,391 10,391 10,391 Other Fixed Assets 1,462 1,508 4,035 4,035 4,035 4,035 4,035 4,035 Total Fixed Assets 94,088 119,021 141,011 157,318 176,144 197,995 224,866 257,812 Total Assets 122,696 148,657 182,063 179,254 199,448 222,958 252,517 288,738 Payables 10,357 12,150 18,244 19,912 20,223 20,638 21,854 23,187 Sales in advance of carriage 9,087 10,786 11,270 13,901 15,181 16,730 19,187 22,195 Others 853 1,928 8,630 8,630 8,630 8,630 8,630 8,630 Total Current liablities 20,297 24,864 38,144 42,443 44,034 45,998 49,671 54,012 Overdraft facility 0 0 25,218 52,187 102,460 149,889 195,862 237,956 Bank Loan 61,965 89,012 122,566 107,564 92,802 81,316 69,831 59,391 Other 9,225 6,552 2,098 2,098 2,098 2,098 2,098 2,098 Total Long Term Liabilties 71,190 95,564 149,882 161,849 197,359 233,303 267,791 299,445 Shareholders Equity 31,155 28,186 -6,009 -25,084 -41,991 -56,389 -64,991 -64,765 Total Shareholders equities and liabilities 122,696 148,657 182,063 179,254 199,448 222,958 252,517 288,738 Cash Flow Statement Operating Cash Flows -537 2,738 1,214 2,948 1,431 4,767 12,200 22,410 Investing Cash Flows -39,466 -31,878 -76,766 -16,182 -36,941 -40,711 -46,688 -54,007 Financing Cash Flows 47,556 25,965 67,601 11,967 35,510 35,944 34,488 31,597 Movement in cash and cash equivalents Beginning Cash Balance 6,840 14,393 11,218 3,267 2,000 2,000 2,000 2,000 Net movement in cash 7,553 -3,175 -7,951 -1,267 0 0 0 0 Ending Cash Balance 14,393 11,218 3,267 2,000 2,000 2,000 2,000 2,000
  21. 21. 21 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com KENYA AIRWAYS FACT SHEET Kenya Airways Ltd Operating Statistics Kenya Airways Ltd Principal Shareholders ce: Ann S Source: Annual Reports, Genghis Research Source: Annu Source: Annual Reports, Genghis Research Kenya Airways Ltd Aircraft in Service Kenya Airways Ltd Revenue Mix- 2015 ce: Annu Source: Annual Reports, Genghis Research Figures in Mns. Source: Annu Source: Annual Reports, Genghis Research *As of September 2015, the fleet in service were 48 with an additional Boeing 787-8 and Boeing 737-800 delivered and 5 Boeing 767- 300 and Embraer 170 awaiting return/ sale. In January 2016, 2 Boeing 777-200 were confirmed sold and now awaiting delivery to Omni International. Parameter FY15 FY14 FY13 FY12 Passengers carried 4,179,046 3,719,590 3,664,844 3644492 y-o-y Growth 12.35% 1.49% 0.56% RPK's (Million) 9,793 9,309 9,579 9943 y-o-y Growth 5.20% -2.82% -3.66% ASK's (Million) 15,406 14,188 13,937 13875 y-o-y Growth 8.58% 1.80% 0.45% Cabin factor (%) 63.6 65.6 68.7 71.7 Cargo Tonnes lifted 73693 71340 69871 62504 Par yield/RPK incfuel Surchange (Usc) 9.55 10.47 9.81 9.9 Passenger Seat Factor 0.64 0.66 0.69 0.72 NameofShareholder Number ofShares %Shareholding PermanentSecretary totheTreasury 445,920,557 29.8% KLM-KoninklijkeLuchtvaartMaatschappij 400,020,026 26.7% Standard Chartered NomineesLtd Non-residentA/C KE11752 143,000,000 9.6% Standard Chartered NomineesLtd A/C KE17682 71,116,080 4.8% Standard Chartered NomineesLtd A/c9187 35,906,095 2.4% Standard Chartered NomineesLtd A/c9230 20,630,773 1.4% Gulamali Ismail 10,424,100 0.7% Vijay KumarRatilalShah 9,309,060 0.6% MikeMainaKamau 8,003,940 0.5% Old MutualLifeAssuranceCompany Ltd. 7,477,369 0.5% Othershareholders 344,661,035 23.0% Total 1,496,469,035 100.0% Aircraft as of March 2015 FY15 FY14 FY13 Boeing 787-800 6 1 0 Boeing 777-300 3 1 0 Boeing 777-200 4 4 4 Boeing 767-300 5 6 6 Boeing 737-800 6 5 5 Boeing 737-700 4 4 4 Boeing 737-300 4 4 5 Embraer 190 15 15 12 Embraer 170 3 5 5 B737-300 Freighter 2 2 1 B747-400 Freighter 0 0 1 Total 52 47 43 90,408 9,783 2,080 7,890 Passengers Freight and Mail Handling Others
  22. 22. 22 | P a g e EQUITY RESEARCH Kenya Airways Analytical NoteBloomberg: GNCP <GO> Think Business Awards 2015 Winner of 8 Awards at the 2015 Think Business Awards www.genghis-capital.com Research analyst certification: The research analyst(s) primarily responsible for the preparation and content of all or any identified portion of this research report hereby certifies that all of the views expressed herein accurately reflect their personal views. Each research analyst(s) also certify that no part of their compensation was, is, or will be, directly or indirectly, related to the view(s) expressed by that research analyst in this research report. Disclosures: This research report is for distribution only under such circumstances as may be permitted by applicable law. This research report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient, even if sent only to a single recipient. This research report is not guaranteed to be a complete statement or summary of any securities, markets, reports or developments referred to in this research report. Neither GCL nor any of its directors, officers, employees or agents shall have any liability, however arising, for any error, inaccuracy or incompleteness of fact or opinion in this research report or lack of care in this research reports preparation or publication, or any losses or damages which may arise from the use of this research report. Recommendations guide: Analysts’ stock ratings are defined as follows*: Strong Buy (SB): The stock’s total return* is expected to be more than 30% (or more, depending on perceived risk) over the next 12 months. Weak Buy (WB): The stock’s total return* is expected to be in the range of 15% to 30% (depending on perceived risk) over the next 12 months. Hold (H): The stock’s total return is expected to be in the range of 5-14% over the next 12 months. Sell (S): The stock’s total return is expected to be less than 5% over the next 12 months. Speculative Buy: Genghis Capital may issue a “Speculative Buy” when the Research Analyst covering the Company is of the view that the risk/reward trade-off is somewhat less compelling than that of a BUY rating. These companies tend to have very high upside potential, but also a great degree of risk or uncertainty with regard to future financial results. *Total return is calculated as the sum of the stock’s expected capital appreciation and expected dividend yield. Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark** Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. Disclaimer: The content provided on this document is provided as general information and does not constitute advice or recommendation by Genghis Capital Ltd and should not be relied upon for investment decisions or any other matter and that this document does not constitute a distribution recommending the purchase or sale of any security or portfolio. Please note that past performance is no indication of future results. The ideas expressed in the document are solely the opinions of the author at the time of publication and are subject to change without notice. Although the author has made every effort to provide accurate information at the date of publication all information available in this report is provided without any express or implied warranty of any kind as to its correctness. You should consult your own independent financial adviser to obtain professional advice before exercising any decisions based on the information present in this document. Any action that you take as a result of this information, analysis, or advertisement is ultimately your responsibility. Genghis Capital Ltd, Delta Corner – PWC Building , Westlands, Nairobi. Tel: +254 20 2774760 Fax: +254 20 246334

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