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.

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