The king of good times is facing hard times. Launched in 2006, with much fanfare by its Chairman, Mr. Vijay Mallya, Kingfisher Airlines (KFA) is presently in dire financial straits. After the euphoria abated, KFA’s strategy, performance and financial health has been questioned from mid-2008. Now the company is facing major financial and operational problems. The press statement from KFA, on 12 March 2012, highlights the challenges:
“The flight loads have reduced because of our limited distribution ability caused by IATA suspension. We are therefore combining some of our flights. Also, some of the flights are being cancelled as a result of employee agitation on account of delayed salaries. This situation has arisen as a consequence of our bank accounts having been frozen by the tax authorities. We are making all possible efforts to remedy this temporary situation.”
KFA is a good case to understand the impact of failure in risk management. The management ignored the warning signs of stormy weather and failed to navigate the company into safety. With hindsight, some of the important decisions made by the airline appear incorrect. Let us analyse the top 5 risks.
1. Strategic Risk – Market Analysis
KFA was launched as a premium business class airline. That was the first mistake, a lack of understanding of customer requirements and basing a decision that luxury sells in airlines. Organizations focus on reducing costs and usually just CXOs are allowed business class travel. Rest of the staff mostly travels by economy class. Moreover, buying most expensive business class tickets doesn’t go down well when seniors aim to project the image of walking the talk.
Even consultants, whose travel tickets are paid for by clients, hesitate to book KFA tickets. It appears that they are abusing privileges. Hence, the market size for business class tickets is small in India.
Secondly, internationally Southwest Airlines operating model has proven successful. It is a low-cost airlines, provides minimum frills to customers at reasonable rates. Mr. Mallya, highly successful in liquor business, didn’t comprehend the differences in customer preferences within the two industries. Customers may buy expensive alcohol, but not airline tickets, since the total cash outflow is higher. It is a price sensitive market. Therefore, KFA adopted an incorrect strategy from the start as it failed to understand the market dynamics.
2. Strategic Risk – Merger with Air Deccan
KFA acquired Air Deccan, a low-cost airline in 2007. Five years of operations is a key criteria for an airline to fly internationally. Hence, KFA acquired Air Deccan’s international flying rights and simultaneously entered the cheaper market segment. It made the following announcement in September 2008 financial results commentary:
“The merger of the two operating airlines into one corporate entity has also enabled savings on operating costs such as Engineering and Ground Handling, Insurance and Catering. Employee costs have also been addressed through an integrated organization which enabled the Company to terminate the contracts of most expatriate staff and impose a hiring freeze on new appointments.“
After the merger, first signs of trouble cropped up. As per a Business Today article, it became the largest Indian airline with 27.5% market share, and domestic travel increased by 30%, however it didn’t make profits. Despite the fact the its main rival – Jet Airways – continuously showed profitable quarters.
KFA showed growth in numbers while having lost the strategy. With the merger, it lost its brand image of a premium business class airline. It expanded with the speed of a jet without building a base and resolving the post merger challenges. This set the course for a bumpy ride.
3. Strategic Risk - Investment in Planes
According to 31 March 2011 ending annual report, KFA flew 366 domestic flights and 28 international flights. It owned 67 aircraft.
“Aircraft Engine/Lease Rentals: Aircraft/engine lease rentals stood at Rs. 984 crore (USD 197 million) during the twelve month period from April 2010 to March 2011. Your Company operated 67 aircraft (scheduled and non scheduled) in the year under review, 13 of which are owned through finance leases and 54 are held under operating leases.”
Business Today article mentions that presently the airline owns 63 planes and a few have been returned to the lessors. However, the plane financing problem isn’t new. In September 2008, after the merger with Air Deccan,in financial results commentary KFA stated the following:
“Two aircraft have already been returned to Lessors with no additional cost, and the Company is in discussion for the return of a further eight aircraft. The impact of this capacity contraction will be visible during the second half of the Financial Year.”
After the merger, according to the Business Today article, the airline refused to take delivery of 5 Airbus A340-500. It had over 90 aircraft in Airbus books and no delivery was taken after 2008. This is a case of investment plans made under a cloud of unknowing.
4. Financial Risk - Excessive Debt
In the December 2011 quarter unaudited financial results, signed by the Chairman Mr. Mallya, the following note is given:
The Company has incurred substantial losses and its net worth has been eroded. However, having regard to capital raising plans, group support, the request made by the Company to its bankers for further credit facilities, planned reconfiguration of aircrafts and other factors, these interim financial statements have been prepared on the basis that the Company is a going concern and that no adjustments are required to the carrying value of assets and liabilities.
KFA posted a loss of Rs 1027.39 crore (USD 205.95 million) in December 2011 quarter. As of 31 March 2011, its net worth was negative at Rs 3633.08 crore (USD 728.29 million). It was last positive in March 2008, and now the picture is dismal. Presently, KFA has a total debt of Rs 7057.08 crore (USD 1414 million) and total accumulated losses of Rs 6000 crore (USD 1202 million). The banks refuse to extend further credit as the non-performing assets (NPA) will jeopardize the profitability and liquidity of the banks.
Here it is a clear case of excessive debt and poor cash flow management systems. The situation has gradually worsened from March 2008 and in three years the capital is completely eroded. A better financial risk management may have helped mitigate the problem. It appears no one in the company was monitoring the risk dashboard. Maybe they were flying high on optimism.
5. Operational Risk – Fuel Costs
It’s a well know fact in aviation industry that most airlines nosedive due to high fuel costs. The rise in fuel costs are an uncontrollable risks as the price of petrol is set internationally. Additionally, in India, states charge heavy sales tax on petrol. Hence, the fuel costs are much higher in India. KFA annual report of 31 March 2011 acknowledges this issue:
Aircraft fuel expenses: Expenditure on fuel stood at Rs. 2274 crore (USD 456 million) during the twelve month period from April 2010 to March 2011 accounting to 28% of the total costs. While the average fuel prices have come down from a high of Rs. 74 per litre in August 2008, prices have steadily risen through the year and ended 34% higher than prices at beginning of the year.
As given in the commentary on the results for the half-year ended 30th September 2008, KFA was aware of the problem:
The Aviation Industry is going through a challenging phase globally, driven primarily by spiraling fuel costs, which hit an un-precedent USD 147 per barrel in July 2008. The Indian industry was hit more adversely due to the cumulative impact of Customs Duty and Sales Tax on account of this sharp increase in international fuel prices. The average price of ATF in the six month period from April to September 2008 increased by about 60%. The impact on Kingfisher Airlines alone was to the tune of Rs.640 Crores (USD 128 million).
Most airlines to recover fuel costs increase the number of seats in the aircraft by better use of space. KFA couldn’t do it, as it projected itself as luxury class. Despite enjoying an occupancy rate of 75-85%, the company failed to break-even. Although the management was aware of the truculent factors in aviation industry it failed to take preemptive measures timely.
A look at the 31 March 2011 year-end annual report reveals that KFA had 7-8 directors, with just one executive director. The audit committee had 3-4 directors and didn’t seem active, since there were just 4 meetings during the year. Since inception of the company, three CEOs have come and gone. Mr. Vijay Mallya, the Chairman, controls the company. The board of directors have not actively participated in charting the route of the company. Hence, pilot of the company is responsible for the downward spiral of KFA. As the banks and government refuse to give a life jacket to KFA, the probability of safe landing is low.
1. Kingfisher Airlines - Media statement 12 March 2012
2. Kingfisher Airlines – 31 March 2011 Annual Report
3. Kingfisher Airlines – 31 December 2011 Unaudited results
4. Kingfisher Airlines – Commentary on results for half year ending 30 September 2008
5. Losing Color – Business Today article.
Author: Sonia Jaspal is a chartered accountant and certified internal auditor with 15+ experiences in risk management and corporate governance. She blogs at Sonia Jaspal's RiskBoard http://soniajaspal.wordpress.com