Kenya Airways’ global expansion is both a strategic aspect of the country’s economic diplomacy and a bold statement of where the emerging Kenya places herself in a fast changing world. Nick Wachira reports
It is Thursday midday at the Kenya Airways Cargo Centre at Jomo Kenyatta International Airport, and Dr Titus T. Naikuni, the boss of Kenya Airways, is in an upbeat mood as he prepares to launch the airline’s first dedicated cargo freighter.
Half an hour earlier, he was on a routine visit to the heart of KQ’s cargo operations. He now emerges on the first floor office carrying two empty First Aid boxes, to find Mr Mbuvi Ngunze, the chief operating officer.
“Hi Titus, What are you doing walking around with medical equipment?” teases Mr Mbuvi.
“I stumbled on these in an office somewhere,” says Mr Naikuni, “These things cost us Ksh5000 a piece, and you wonder how many are lying abandoned somewhere around the company.”
Then Dr Naikuni eyes a wall-to-wall map of the world depicting destinations that KQ flies to, and without warning shifts into an animated conversation on a cost-saving plan that could save money to the tune of millions, and a proposal on the West African cargo market that could potentially transform how countries along the 4500 kilometre coastline – from Dakar in Senegal to Luanda in Angola – trade with the world. A flight from Dakar to Luanda takes five and a half hours. Such proposals are suggestions from employees.
If you are wondering what disused first aid boxes, and a high-minded conversation about conquering the west African aviation market have in common, welcome to the complex world that the CEO and the COO of sub-Sahara’s top national carrier are building.
First, in a harsh environment where fuel prices are very volatile and labour costs keep rising, Dr Naikuni must keep a close look at costs at all levels in order to return to profitability earlier. Secondly, the airline must remain focused on executing the expansion programme as an investment to take advantage of the resurgence of the African economy and to boost profitability in the future, no matter how bleak the present might look for now – at least in the next two years.
“We are investing heavily for our future profitability,” he says, “The headwinds might have been tough on us and the industry in the last year or so, but when the chips start falling in place in the next one to two years, we see a silver lining ahead in the sky.”
This hawk-eyed approach to cost-saving in times of adversity saw the airline recently strike a deal with its component suppliers that is set to save up to Ksh5 billion (US$60 million) over the next five years, following the re-negotiation of contracts. The savings arise from improvement in commercial terms, service levels, contractual terms and conditions, as well as significant direct and actual cost savings; coupled with the benefits of the planned fleet expansion.
Rising African Giant
Over the last decade, Dr Naikuni has led one of the most ambitious expansions of an African airline – rivalled only by the state-sponsored Ethiopian one. Within a decade Naikuni has led the transformation of KQ from a middling carrier of 16 aircraft carrying 1.5 million passengers annually (mainly from Europe to Africa and vice versa), to a continental giant with more than double the fleet and passengers. This has translated into about fourfold growth in revenues from Ksh27 billion when Mr Naikuni took over to Ksh106 billion in 2012; and the net profit grew from Ksh868 million to Ksh4 billion during the same period.
Even in the last financial year, when KQ reported a loss of Ksh7 billion on revenues of Ksh98 billion, the economics of the airline’s business remained sound and cashflow positive. This year the business is on the rebound, with KQ reporting a dramatic improvement in profitability. Indeed, the airline noted, the second half of 2013 saw a significant reduction in the reported loss compared to the first-half results. Overall, KQ’s loss was contributed to by a Ksh10 billion reduction in revenue on the European routes due to the Greek and EU debt crisis, and the appreciation of the shilling against the dollar. Costs remained flat.
“We expect a significant reduction in net loss in the financial year 2014, driven primarily by an expected increase in revenue, slight decline in fuel costs, flat back-office costs and efficiency benefits of newly acquired and leased aircraft,” wrote Citi analysts Andrew Light and Nithin Pejaver in a recent note to their clients. “Operating cashflow in financial year 2013 and ending cash were better than expected due to higher advance ticket sales and more financing raised for aircraft pre-delivery payments than we had expected.”
If KQ’s performance was to be judged on core operating profits as measured by earnings before interest, taxation, depreciation, amortisation and leasing of aircraft and engines (EBITDAR) its results would appear differently. While EBITDAR is just another alphabet soup of an accounting acronym denoting operating profits only separated from its sibling EBITDA by the letter ‘r’, the two accounting measures make a world of difference when it comes to understanding the health of an airline. Take for instance the just- concluded financial year when Citi estimates that KQ made an EBITDA loss of Ksh3.1 billion, but a positive EBITDAR of Ksh4.2 billion.
These two numbers are separated by Ksh7.3 billion which corresponds to what KQ pays to lease aircrafts and engines, which when included with the cost of borrowing and other non-operation expenses in the calculation distorts the true health of a business. EBITDAR is a popular measure of profitability in the airline industry that allows investors to compare the profitability of airlines without the distortion of how they acquire their aircraft and how they finance their asset base or capital structure.
The face of Kenya
However, as a national asset, KQ must be viewed in a much wider context and not just like another business to be measured against a pretty income statement and a bulging balance sheet (at least within reasonable limits to take care of shareholder interests). KQ’s place in Kenya can be likened to what the Emirates, Qatar, Ethiopian and Turkish airlines are to their home countries – these airlines exist to deepen the trade and economic links of their nation and the world. Hence the huge state subsidies and protection that they enjoy.
Today, KQ not only accounts for more than half the passengers handled at the Jomo Kenyatta International Airport, but if the airline were to be ranked as an industry, with its Ksh106 billion in revenues in 2012, it ranks as Kenya’s biggest foreign exchange earner, ahead of tea exports. As a company KQ is the fifth-largest contributor to the economic output of the country as measured by Gross Domestic Product (GDP), a measure of all economic activity in the country, behind agriculture (Ksh223 billion), wholesale and retail industry (Ksh166 million), and manufacturing.
Yet, in the simplistic world of retail and portfolio investors looking for short-term gains on the Nairobi Stock Exchange, the airline is just another listed firm that is valued at Ksh16 billion by the public markets. Yet, to the country – and the Treasury which now owns 29 per cent of the company – KQ is a major sub-economy of Kenya, given its foreign exchange earning power, the number of people it employs directly and indirectly, and the multiplier effect that results from both its direct spending and the industries it supports, such as tourism, energy, transport, food processing, horticulture, and smallholder farming.
“It is true,” Mr Naikuni says, “that in many places that we fly to we are seen as the face of government, business and even Kenya, as we have to take the lead in negotiating bilateral services agreements together with the Ministry of Transport. Today, we fly to around 60 destinations, which is more places and countries than Kenya has foreign missions.”
For many Kenyans, the national carrier evokes an exaggerated sense of scale, expectation, national pride, and sometimes hurt feelings; yet, KQ only generates five per cent of its revenue in the country. However, for many Africans (who until a few years ago had to take a flight to Paris or London first before flying down to South Africa) KQ is the only consistent ticket out of their countries. In a crisis situation, it is the last airline out of the country, as happened last year when Kenya’s Foreign Minister Moses Wetangula and foreign aid workers were caught up in the Bamako coup d’état in Mali.
The airline’s role has grown in recent times as more African countries start experiencing rapid growth because of what is now termed the “Peace Dividend” after the cessation of decades of bloody armed conflicts and civil strife. KQ is taking an increasingly larger role in linking scores of these countries to the rest of the world, particularly the Middle East and Asia.
In many of these markets, there are few airlines that could measure up to international standards – such that at some African airports, KQ has had to help fix air navigation equipment, has bought fire engines, and sometimes has paid higher rates to keep the airports running so that its aircraft can land at night.
“We don’t run an airline business, we run a security and a people business,” says Mr Ngunze, “That is why when I joined KQ, in September 2011, Titus told me to take a year-and-half to learn the business, in theory, but then of course he expected results much faster.”
To the wider world, many were seemingly surprised to see the KQ-sponsored Kenyan National Sevens Rugby team beat the mighty New Zealand on their home turf in the IRB 7s World Series and sail to the finals against England. As the Kenyan team outplayed England to the last minute, the chat on social media turned from shock to an observation on not only how Kenya has a powerful team, but that KQ – whose logo was emblazoned on the players’ rugby shirts – was a relatively large African carrier with huge global ambitions. That is the reality of the growth story that Dr Naikuni and his team have been selling in the last year since they raised Ksh14 billion in a rights issue to underwrite the carrier’s global ambition.
Sky is the limit
In the next decade, Dr Naikuni and his team have authored an audacious growth plan dubbed “Project Mawingu” (or the “Sky”) that will not only see KQ double its route network from the current 60 destinations to 115 by 2021, flying into 77 countries. The fleet is projected to grow from around 40 aircraft in 2013 – of which a quarter are huge wide-body vehicles – to 107 (of which two thirds will be wide-body).
“In terms of fleet play, today we have 42 planes, by the end of next year we shall have 48; 55 by March 2015 and 60 by March 2016, flying to 78 destinations,” says Mbuvi.
As KQ plans to launch flights in the near future to far flung and exotic cities such as Shanghai, Chengdu, Chongqing, Kunming, Urumqi, Ahmedabad, New York, Washington DC, Hanoi, Prague, Moscow, São Paolo, Seoul, Perth and others, it is betting on two significant trends reshaping the global economy.
Though the airline makes its expansion decisions purely on the basis of the profitability of its routes, the success of a national airline is not judged purely by its income statement. To the keen observer, KQ’s global expansion is both a strategic aspect of the country’s economic diplomacy and a bold statement of where the emerging Kenya places itself in a world in flux.
The big challenge
In spite of the recent setbacks, KQ has largely remained one of the most profitable airlines in the world in the last decade, as the industry wobbled from one crisis to another, starting with the USA 9/11 terrorist attacks, the Great Recession of 2008, the European debt crisis; and, closer to home, the Somali war, which forced the airline to shrink the frequency of its flights to London from two to one daily.
“Europe shrunk in capacity by 30.4 per cent compared to the same quarter in the previous year due to rationalisation occasioned by the eurozone crisis and anticipated lower demand during the Kenyan electioneering period,” said Dr Naikuni.
Passenger uplift to Europe at 83,506 was a reduction from the previous year’s level of 113,184. KQ responded to this drop by reducing the frequency of flights, which helped push seat occupancy from 65.2 per cent to 75.7 per cent. This helped save on operating expenses such us fuel and hotel bills for staff flying on half-empty planes.
Overall, the company put into the market a capacity totalling 3143m seat kilometres, which was 4.5 per cent below last year’s level. The decline during the period was as a result of discontinued operations to N’Djamena, Muscat and Jeddah. New Delhi joined the network in the first quarter of 2012.
“Kenya Airways has consistently outgrown and has been more profitable than global and African airline averages and has been significantly more profitable than most European airlines,” observed Nithin Pejaver, an analyst at Citi. “Being the largest of only four listed African airlines, [it] offers an almost unique investment opportunity into the expected strong economic expansion in Africa, and its significant implications for air travel growth, both passenger and air cargo. Kenya’s location is well placed to benefit from fast growing intra-Africa and Africa-Asia traffic flows.”
In the last decade several shocks have combined to reshape the face of the global aviation industry and given rise to the ambitious opportunities that KQ is now chasing with its expansion programme. Some of these shocks have manifested themselves as stealth forces that have gradually built up and are now visible, yet others have been violent and disruptive shocks. The most visible shocks were the disruptions occasioned first by the 9/11 terrorist attacks, which saw the aviation industry saddled with additional security and insurance costs, and then the financial and debt crisis in North America and Europe. These shocks precipitated a major reorganisation in the US and European airline industry which saw several big carriers go bankrupt and were eventually forced to merge or to come closer by organising their sales efforts around three mega-airline alliances, namely SkyTeam, Star and One World.
Poignantly, even before 9/11 and the Great Recession, the large North American and European airlines – also known as “legacy” carriers – were sitting on decades long labour-related challenges that were too complicated to unwind. After years of yielding generous concessions to the labour unions, the legacy carriers were facing huge pension and medical costs from retiring employees just at the time when costs, particularly fuel, were rising exponentially, and competition from low-cost carriers (LCCs) was intensifying. Legacy carriers globally also faced problems of ageing fleets that would require billions of dollars to replace, and a hostile regulatory environment that continues to impose costs in the form of new taxes to curb global warming and noise pollution.
At this time a major trend emerged as new aviation hubs started emerging. For over 50 years the legacy carriers had dominated world travel as these economies enjoyed a post-second World War boom. North America and Europe became the dominant air transport corridor serving the western world and the rest of the planet. In simple terms, the legacy carriers took traffic from the west to trade or tour the rest of world.
However, with the turn of the century, and largely unnoticed, the rest of the world economy – particularly Brazil, Russia, India and China started rising relative to the American economy and major transformation started happening on the ground. For instance, the combination of a growing middle class, rise of megacities with populations of over 20 million people, and regional integration saw emerging market airlines start to build airports to accommodate the rising demand for air transport.
However, the aftershocks of the Great Recession of 2008 would help unleash the benign forces that are now reshaping the industry.
“It is this period that people started noticing the emergence of gulf carriers,” says Mr Mbuvi.
At around the time that the large North American and European airlines were experiencing the Al Qaeda-induced shock in the early years of the last decade, and Middle East governments, threatened by the risk that one day their vast oil reserves would run out, started investing heavily by diversifying their economies with a focus on tourism.
This saw Gulf States such as Emirates, Abu Dhabi and Qatar investing heavily in both building huge state-of-the-art airports and making huge orders for the latest aircraft. It is at this point as well that aircraft manufacturers such as Boeing and Airbus unveiled aircraft such as Airbus A380, Boeing 777-300 and Boeing 787 that would revolutionise the world of travel. These aircraft would not only make it possible for airlines to carry more passengers but also offer major savings on fuel consumption, enabling aircraft to stay airborne for more than 14 hours while still offering six star flight service.
“This is important,” says Mr Mbuvi, “Because with fuel constituting 50 per cent of an airline’s costs, these new aircraft were offering the possibilities of going faster, further, and cheaper.”
This came as a major advantage to gulf carriers such as Emirates, Etihad and Qatar, which enjoy the geographic advantage of being located at the mid-point for anyone travelling from North America to the Far East. Already, due to their geographical advantage, these carriers were located at a point where they could reach 86 per cent of the world population within an eight-hour flight. With the new aircraft from Boeing and Airbus, the Middle East carriers could fly passengers from Dubai to Los Angeles without stopping for refuelling. This trend has not spared African carriers, which have lost 10 per cent market share to gulf carriers in the last decade. It also happened that while all these financial and technological forces were still at play, major economic, demographic and political shifts were and still are underway in the emerging and frontier economies in Asia and Africa.
Demographic and economic shifts
Traditionally most of the travel in the world happened in North America and Western Europe, spurred by the rapid economic expansion that followed the post-World War II era. But all this has started to change in the last decade, particularly in Africa where civil wars have been replaced by a peace dividend and the fastest economic growth experienced by any continent.
According to a global markets forecast published by Airbus looking at the aviation market between 2012 to 2031, air transport growth is now highest in expanding regions such as China, India, Middle East, Asia, Africa, Latin America and Eastern Europe, which the aircraft manufacturer predicts will grow at six per cent annually over the next decade. Western Europe, Japan and North America will grow by four per cent. However, the growth in mature markets pales in comparison to the emerging markets when mapped against the population the legacy carriers are currently serving. For instance, the emerging markets are serving countries hosting six billion people – one billion of whom are in Africa, compared to one billion people in the developed world. The emerging markets today account for 79 per cent of Airbus’ aircraft order backlog.
“Billions of people will increasingly want to travel by air,” notes John Leahy, a chief operating officer at Airbus. “Air travel has doubled every 15 years, and it will double over the next 15 years.” In 2010, 2.7 billion passengers were carried by air.
One telling statistic that will contribute to this growth – and transform Africa and carriers like Kenya Airways – is the upsurge in the number of aviation megacities that handle more than 10,000 long haul passengers per day. According to Airbus, there were only 42 megacities in the world in 2011, of which 23 were located in North America and Western Europe and one in South Africa. However, by 2031, there will be over 90 megacities. Aviation megacities are important because long-haul traffic tends to be concentrated on such travel hubs. This is where Africa, as an economic powerhouse, starts to emerge with six of these aviation megacities located on the continent in: South Africa, Kenya, Ethiopia, Angola, Ghana and Nigeria, where Kenya Airways is already a major carrier.
According to Airbus, “more people, bigger cities, more wealth” will drive demand for air transport, particularly in the emerging market when more first-time flyers among the growing middle class will be buying air tickets. Growing tourism and internationalisation will stimulate demand. African governments could spur faster growth by opening up the heavily regulated air transport industry to competition.
This is the context that KQ’s management finds itself in when evaluating the future of the industry and the opportunity that the airline must exploit in the next decade as underlined by the Project Mawingu expansion project.
In KQ’s view, the airline’s expansion plan under Mawingu should see the number of passengers it carries increase from 3.1 million in 2011 to nearly 14 million by 2021, which creates a sense of urgency to upgrade the capacity of Jomo Kenyatta International Airport to handle at least 22 million people.
Analysts such as Pejaver of Citi have even higher expectations, projecting that the airline should be carrying 12.8 million people by 2015, but KQ’s forecast is a more modest 10 million.
Boeing in its Current Market Outlook projects an even rosier picture for the African aviation industry in the next two decades, driven by the number of travellers, the number of seats that airlines will put in the market and the length of the journeys these carriers will be taking. According to Boeing, passenger traffic, as measured by the number of fare- paying customers multiplied by the length of the journeys they will be taking, also known as revenue passenger kilometres (RPKs) in the industry, will grow 467 billion kilometres to 725 kilometres, which is 55 per cent growth. The most notable of this growth will come from travel within Africa, which will double from the current 11 per cent of the total RPKs to 23 per cent; and from Africa to the Middle East and South East Africa, which will grow from 9.9 per cent to 21.3 per cent. While the volume of traffic to the traditional European market will remain the single-largest market with its share increasing from 29 per cent to 35 per cent, it is quite clear that the future of carriers such as KQ lie within Africa, in the Middle East and growth markets such as India and China. This would explain the strategic direction that the airline is now taking in terms of choice of new routes and the two aircraft types it will be using.
Boeing versus Embraer
Meeting this projected demand has meant making a calculated bet on how KQ anticipates the African aviation market (which accounts for half of its revenues) will grow; the routes it will target and the type of aircraft it chooses.
In 2009 KQ made a highly anticipated decision by ordering nine Boeing 787 Dreamliners and followed this in 2011 with the acquisition of 10 fully-owned Embraers.
The Dreamliner, a wide-body aircraft with its vaunted technological advances, would be used to service the South Asia and European markets. More strategically, albeit controversially, was the choice of the Embraer jet, a mid-range, narrow body aircraft that is better suited for serving short haul markets that lie within three to four hours from the Nairobi hub. According to Mr Mbuvi, the Embraer aircraft seemed to be natural fits for KQ on account of the Nairobi hub’s strategic geographical location, air-traffic growth projects and the economics of that aircraft.
Given that half of KQ’s revenue is generated in Africa – in those markets between three to four hours from Nairobi or within 4500 kilometres (most of East, Central, southern African nations) – the airline’s chief operating officer argues that the Embraer was an ideal choice at this stage when KQ is developing these routes where the passenger loads are smaller than the typical Boeing 737 aircraft, and require more regular frequencies.
“KQ operates a two-wave strategy from the Nairobi hub, where in the morning we take passengers who have just arrived from Europe, Middle East and Asia across the continent, and in the afternoon we bring those travelling outside the continent back home to transit to the rest of the world,” says Mr Mbuvi.
Increasingly, the African travellers are heading East to China, India and Middle East. They are mainly traders, labourers and tourists coming to Africa from China and looking up to KQ to take them to the interior of Africa by day and night so that they can do business on the continent.
“We are also among the few airlines in Africa that operate at night, taking many of the businessmen travelling to South Africa and much of West Africa to their destinations in time for their morning meetings,” says Mr Mbuvi. “Our strategy with the expansion plan is to offer many of our customers convenient travel options.”
This is important, as intra-Africa travel is becoming the next big thing. A report by the International Civil Aviation Authority (ICAO) published in 2006 and looking at the African aviation market between 2005 and 2020 forecasts that aircraft movement within Africa will triple in the next seven years. This will be in traditional markets where KQ is big such as the city pairs between Entebbe-Nairobi, Dar Es Salaam-Nairobi, and Kilimanjaro-Nairobi, where the airline plans to launch a low-cost carrier, Jambo Jet.
However, even as KQ mulls over its expansion plans, it has to contend with other strategic factors at play that include how fast JKIA can expand its planned new terminals and parking spaces, and how fast the airline can train enough pilots and captains to man its expanded fleet.
According to Boeing, the world will continue to experience a shortage of pilots as demand for air travel increases. Overall Boeing estimates that one million new commercial airline pilots and technicians must be trained by 2031. Africa will need 14,500 new pilots.
In most parts of Africa where Kenya Airways wants to expand, it will have to play a critical and rightful role engaging national governments to open up the competitive space, as well as invest in infrastructure, because KQ will increasingly continue connecting most of Africa to the rest of the world.