How to Predict an Airline Financial Crisis Prepared for: Aircraft Finance and Lease Russia & CIS Conference 14 April 2016 0
1. WHO WE ARE 2. THEORY 3. PRACTICE 20 min presentation 5 min Q&A 1
WHO WE ARE One of the World s Largest, Most Experienced Aviation Firms 53 years in air transport 100 aviation staff Covering the whole industry More than 150 airlines clients 2
WHO WE ARE ICF has End-to-end Aviation Industry Capability in 4 Specialized Practices 3
WHO WE ARE Andras Bognar - the Presenter Economist Airline, Airport and MRO specialist 13 years in the industry Speaks Russian 4
1. WHO WE ARE 2. THEORY 3. PRACTICE 5
THEORY Without a Turnaround Financiers are Likely to Lose Everything Without Turnaround Airlines tend to be highly leveraged The business is seasonal Little cash off season Airline cash-flow is quickly disrupted at the hint of bankruptcy Employees are paid before creditors Airlines have many employees Airline assets lose value quickly 6
THEORY With a Turnaround Chances of Creditors Being Paid are Better With Turnaround Creditors may recover 40-70% of their money Without Turnaround Creditors may recover ~3% of their money 7
THEORY Two Case Scenarios of Bankruptcies With Turnaround American Airlines: After bankruptcy announcement: Unsecured bonds dropped from 0.4 USD to 0.16 USD / 1 USD Secured bonds traded at 0.75 USD / 1 USD Eventually, all unsecured debt was converted to shares and shares recovered Airport bonds also suffered Airlines are likely to re-negotiate their rents during a bankruptcy Malev: Without Turnaround Unsecured creditors expect less than 2% VEB among them 8
THEORY Problems Tend to Build-up Over Time and can be of any Length hidden crisis denial Examples 7 years for Kingfisher 12 years for Malev 2-3 years for Transaero disintegration collapse Prediction is needed to avoid the worst 9
THEORY Good Financial Results are Triggered by Many Factors External factors Internal factors E.g. exchange rate E.g. capacity addition Macro economic factors Competition Economic factors Absolute cost advantage Relative cost advantage E.g. lower fuel costs E.g. bigger aircraft Product differentiation E.g. better FFP Competitive advantage Organisational factors E.g. leaner organisation Legal and political factors E.g. international route rights Good financial results 10
THEORY So in Theory, Monitoring the Factors can Predict a Crisis For example Altman Z-score formula predicts the likelihood of bankruptcy: Where Z = a*x 1 + b*x 2 + c*x 3 + etc. x 1, x 2, x 3, etc. are different financial ratios of the company a, b, c, etc. are their weightings And if Z is below a certain value, then bankruptcy is threatening 11
THEORY A Similar Logic is Applied to Credit Rating Variables Scores Weighting Combined Score Interpretation Source: www.theairlineanalyst.com 12
1. WHO WE ARE 2. THEORY 3. PRACTICE 13
PRACTICE But Quantitative Prediction Doesn t Always Work Not all factors are possible to measure E.g. passenger loyalty Not all factors are being disclosed by the airlines E.g. details of business plans External factors are too many E.g. competitors increasing capacity, political events, etc. Financial reports show highly aggregated information Hard to see behind them Financial reports summarise the past But we want to see events in advance, not ex-post Management tends to show a picture more favourable for themselves E.g. favourable leasing rates but unfavourable return conditions 14
PRACTICE Formulas Need to be Supported by Judgment Suspicious Signs Sign Interpretation 1 Airline not making money in summer (high season) 2 Airline expands into longhaul flights 3 CEOs changing less than every 2 years It will certainly lose money during the whole year Long-haul represents a much higher financial risk than short-haul E.g. Norwegian suffered financially when long-haul expansion did not go according to plans at first Frequent changes of CEOs mean they can t figure out the solutions to the problems New CEOs tend to change lower level management as well Industry outsider CEOs need min. 2 years to start to feel the business 4 High unit costs High unit costs demand high unit revenues But the airline business is cyclical and yields tend to fall eventually E.g. SAS 15
PRACTICE Suspicious Signs (Continued) Sign 5 Too many aircraft types in the fleet 6 Fleet renewal / expansion at all costs Interpretation Complexity drives higher costs E.g. TAROM has 23 aircraft and 6 sub-fleets Buying aircraft during good years of the cycle means aircraft will be expensive Young aircraft mean less flexibility to decrease capacity when needed E.g. South East Asian airlines recently E.g. Kingfisher ordering A380s 7 Capacity indiscipline Adding capacity at the top of the cycle (or during the downturn) means overcapacity during the downturn 8 Building a transfer hub at all costs Usually happens because local market is small But transfer traffic is very price sensitive 16
PRACTICE Suspicious Signs (Continued) Sign 9 Everything done in house 10 Turnaround half done Interpretation E.g. in-house MRO, Catering, Ground Handling, Tour Agency, etc. Usually leads to many sub-scale businesses with uncompetitive cost levels. Distracts management attention from core business Ties down capital E.g. financially restructured, but not operationally E.g. salaries decreased, but nothing more Temporary solutions will bring only temporary results 11 Acquisitions Especially harmful is the acquisition of losers E.g. Swissair s Hunter Strategy buying Sabena, South African Airways, etc. E.g. Kingfisher buying Air Deccan 12 Organisational inertia Inability to take decisions in a highly competitive environment Typical of government-owned airlines 17
PRACTICE Suspicious Signs (Continued) Sign 13 Schedule unreliability 14 Glamourous headquarters 15 Consuming the reserves 16 CEO / President denying the crisis Interpretation Schedule disruptions in many cases are symptoms of operational disintegration of the airline E.g. strikes over late payments of salaries E.g. ground handlers demanding upfront payment In a very competitive transportation business office luxury is not sustainable E.g. Pan Am headquarters in the centre of Manhattan E.g. Air India headquarters in the most expensive part of Mumbai This is suspicious when it happens contrary to previous practices E.g. selling slots (not exchanging them) E.g. selling and leasing back aircraft If the airline has no cash reserves left the CEO / President needs to prevent a panic If the airline has cash the CEO / President can admit the problems and say they are working on a solution 18
PRACTICE Conclusions 1. The downward slope towards collapse can be of any length 2. A turnaround can save much of the unsecured debt 3. Predicting bankruptcies need a combination of quantitative and qualitative tools, and ideally supported with external viewpoints not encumbered by emotion or politics 19
Thank you! For questions regarding this presentation, please contact: Andras Bognar Senior Manager Airlines +44-788-44-90-781 abognar@icfi.com 20