Soaring Wages Make Kenya Airways a Sell

Recent labor disputes demonstrate employees’ leverage over KQ’s operations and increase doubts about a return to profitability for the East African airline.

Try as it might, Kenya Airways (KQ) just can’t seem to power through its many headwinds.

Photo by Plane Spotter NL
Photo by Plane Spotter NL

Just as the company appeared to have set a course to consistent profits, two recent labor disputes suggest KQ investors better prepare for turbulence.

First, the airline’s pilots threatened to strike unless the company’s board chairman, Dennis Awori, and CEO Mbuvi Ngunze, were removed from their posts, saying that they had no confidence that they could restore the company to a sound financial footing.

Both men have since resigned. Awori was replaced by Safaricom hero, Michael Joseph, while Ngunze’s successor is yet to be announced.

Then, just weeks later, the company’s engineers and mechanics downed their tools in protest of low wages and long exhausting schedules. They returned to the job following a promise to have their pay package reviewed in January.

Labor Unions Have the Leverage

So, what should we, as investors, make of all this?

Well, recent events make it crystal clear that the company’s success is at the mercy of its employees.

Dennis Awori served as board chair for less than a year and Mbuvi Ngunze was appointed as CEO in November 2014. Despite their short tenures, they’ve already guided the airline to its best financial results in years. The company’s operating loss of Ksh 949 million over the most recent 12 months was the closest KQ has come to operating profitably since 2012.

But pilots and mechanics possess rare skills. They’re expensive to train and tough to replace, especially in a relatively small market like East Africa’s. So, the airline needs to do everything in its power to keep them happy.

Rising Wages, Falling Profits

KQ has reported a big earnings loss every year since 2012, and its liabilities now outweigh its assets by nearly KShs40 billion.

Nevertheless, over the past decade, the average compensation package for a Kenya Airways employee has nearly tripled, rising at an average annual rate of 11.2%. This rate is nearly double the rate of pay hikes awarded to management (6.1%).

As you can see in the chart below, the average employee’s wage increased every year except last year, when Awori and Ngunze were in the cockpit. In light of this, it’s easy to see why both of them were sacked.

KQ EmpCosts Vs Revs

If Wages Can’t Be Cut, Alternatives are Few

Let me be clear. I’m not blaming KQ’s workers for the airline’s troubles. They deserve to be paid well for their unique expertise. But an increasing wage bill is a major reason that the airline can’t turn a consistent profit. In 2006, worker compensation was equivalent to 9.6% of KQ’s revenue. In 2015, it was 15.4%.

If labor costs remain at this lofty level, there are scarce few ways for the company to meaningfully widen its margins.

The passenger load factor of 71.6% is already near the top end of its historic range, and adding more flights or routes would entail higher investment in aircraft and substantially increased operating costs.

Headed for a Rough Landing?

Add in the risks of a turbulent election season, a rise in oil prices, or an interest rate hike, and this airline looks to have a very low ceiling.

Fortunately for shareholders, news of Michael Joseph’s appointment as chairman of the board propelled the stock 57% higher over the past two months.

But given the challenges Kenya Airways faces, this looks like a great time for them to collect their gains and disembark.

Looking for news on Kenyan stocks?

Are you interested in news and analysis on the Nairobi Securities Exchange?

If so, sign up below to receive an email alert each time I publish a new article on Kenyan stocks.
[display_form id=5]


Should You Buy African Airline Stocks?

African airlines have been making news of late.

FastJet (RUBI:LN), a new airline backed by the head of EasyJet, will launch in Ghana in a matter of months. And, in June, Kenya Airways (KNAL:KN) concluded a capital-raise for the purpose of doubling its fleet of planes by 2016.

Both news items would seem to be bullish indicators for airline stocks.

Should investors be hopping on board or cooling their jets?

African airlines have been making news of late.

FastJet (RUBI:LN), a new airline backed by the head of EasyJet, will launch in Ghana in a matter of months. And, in June, Kenya Airways (KNAL:KN) concluded a capital-raise for the purpose of doubling its fleet of planes by 2016.

Both news items would seem to be bullish indicators for airline stocks.

Should investors be hopping on board or cooling their jets?

Let’s take a look at the numbers.

Please Fasten Your Seatbelts

We’ll start with Kenya Airways (KQ), the most venerable of African airline stocks.

Photo by Plane Spotter NL

Travel back with me to 1995. In that year, KQ generated over KES2.1 billion worth of profit. That’s an impressive performance considering that the African renaissance was still in gestation at the time.

Since then, Kenya’s GDP has nearly quintupled. So it would be reasonable to expect KQ’s profits to have soared along with it, right?

It would, but if you had invested on that assumption, you’d be sorely disappointed.

I don’t have KQ’s share price info all the way back to 1995, but I do have its earnings figures. They’re plotted in the below chart.

[easychart type=”line” height=”150″ width=”350″ title=”Net Income for Kenya Airways (Local Currency)” groupnames=”Net Income (KES Million)” valuenames=”1995, 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012″ group1values=”2137, 1419, 851, 1314, 993, 2922, 1357, 868, 400, 1302, 3882, 4829, 4098, 4578, -4083, 2035, 3538, 1660″ minaxis=”-5000″ groupcolors=”0070C0, 5E7B3B”]

If you look closely, you’ll see that KQ actually earned less in 2012 than it did in 1995! And this wasn’t a fluke. It outperformed its 1995 earnings in only six of the past 17 years.

KQ’s earnings history is even more lackluster when converted to US dollars.

Let’s assume a very patient investor bought $1000 worth of Kenya Airways’ stock in 1995. Our investor is so patient that she commits to holding her shares for 17 years and will consider 6% annualized earnings growth a satisfactory performance. The chart below superimposes our investor’s expectations on KQ’s actual earnings.

[easychart type=”line” height=”150″ width=”350″ title=”Net Income for Kenya Airways (US$)” groupnames=”Net Income (USD Million), Patient Investor’s Earnings Expectation” valuenames=”1995, 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012″ group1values=”48.3, 24.3, 15.5, 21.8, 15.5, 39.2, 17.4, 11.0, 5.2, 16.8, 52, 66.6, 59, 68.2, -49.4, 25.4, 41.4, 19.8″ group2values=”48.3, 51.2, 54.3, 57.5, 61, 64.6, 68.5, 72.6, 77, 81.6, 86.5, 91.7, 97.2, 103, 109.2, 115.7, 122.7, 130.1″ minaxis=”-50″ groupcolors=”0070C0, 5E7B3B”]

KQ never even come close to meeting our investor’s undemanding earnings growth expectation.

Unfortunately, I don’t have share price data for 1995, but, because stock values are a function of earnings, I’m pretty sure KQ has produced little value for its long-term holders. The stock price has dropped 81% in US dollar terms over the past five years.

Prepare for Turbulence

But I don’t mean to single KQ out. Africa’s other two airline stocks, Air Mauritius (AML:MP) and South Africa’s 1Time Holdings (1TM:SJ), have performed just as miserably.

My data for Air Mauritius (AML:MP) stretches back to 2002. Since then, its profits have dropped from $16.8 million to a $40.8 million loss. Its share price has dropped 35% in US$ terms over the past five years.

South Africa’s low-cost carrier, 1Time Holdings, reported its first earnings as a public company in 2006. In recent years, it doesn’t seem capable of reporting anything but losses. 1Time lost $19.1 million in 2011, and its shares have lost 88% of their value since August 2007.

Why is it so hard to make money in airline stocks?

In short, it’s because their profit margins get squeezed tighter than an oversized duffel bag in an overhead bin.

Check out the net margins for each of the African airlines over the past five years below.

[table id=112 /]

KQ is actually the most successful of the three, yet it’s only keeping two cents of profit out of every shilling’s worth of revenue.

With margins that thin, it’s no wonder that airline profits are fleeting. Variable fuel bills, high airplane replacement costs, encroaching competitors, and air disasters all have the potential to wreak havoc on the bottom line.

Stay Grounded

Airlines are sexy businesses. They’ve got a readily understandable business model based on flying hugely powerful, flashy jet planes.

And they often appear to be much cheaper than other stocks. But there’s a good reason for this. Airlines simply don’t generate much income over time.

So what’s my take on African airlines?

Fly them. Don’t buy them.

What Do You Think?

Am I being narrow-minded by refusing to invest in airlines? Let us know your thoughts in the comments!