Tuesday 19 July 2016
Future appears bleak for Fastjet
Fastjet recently announced that it would be seeking another round of funding from the capital markets to raise money for working capital needs. Since the airline started operations in late 2012 it has struggled to breakeven, having already recorded a cumulative net loss of US$205 million on revenues of US$168 million in the four years of its existence. The Ishka view is that the airline faces an uncertain future until it implements some drastic changes to its operations and overhauls its network and fleet. In the absence of a strong restructuring program, the carrier could be staring at bankruptcy in the near future.
As can be seen from the table above, Fastjet’s fundamentals are particularly weak and the airline is clearly not running a sustainable business. With net loss margins consistently above 100% and negative operating cash flows in each year since it started flying, it is not surprising that the LCC has had to rely on regular equity infusions from shareholders - even for working capital needs. Fastjet has issued new shares every year since 2012 in order to raise money. Despite lower than average load factors for an LCC, the airline has continued to add capacity, which has further contributed to its already unsustainable operations. Fastjet’s cost base is at such a level that even if it could manage load factors of close to 100%, the airline would still be unable to breakeven.
The airline, which is listed on the FTSE AIM, has seen its share price decline by nearly 76% between June 2015 and July 2016. Even the airline’s auditors have consistently raised concerns on the airline’s ability to remain a going concern. During their review of the 2015 annual accounts, the auditors commented, “In forming our opinion on the financial statements, which is not further qualified in respect of this matter, we have considered the adequacy of the disclosure made in Note 1 to the financial statements concerning uncertainties as to the Group's and the parent company’s ability to continue as a going concern; in particular the substantial achievement of forecasts including higher load factors, yields and fuel prices, the successful reduction of the current cost base, any negative cash flow implications of the liquidation of fastjet Aviation Limited, and the availability of such additional equity funding as may be needed if those forecasts are not substantially met. These matters along with the other matters explained in Note 1 to the financial statements, indicate the existence of a material uncertainty which may cast significant doubt on the Group's and the parent company’s ability to continue as a going concern.”
Legacy issues
Fastjet’s problems started even before the airline began flying. Before entering the aviation business, Fastjet, or Rubicon Diversified Investments (Rubicon), as it was called then, was an investment holding company based in London. Rubicon then had an investment in a software services firm which it decided to sell in 2011 following a string of poor performances. Based on a renewed investment strategy, Rubicon decided to exit the software business and enter into the aviation business. As part of that strategy, Rubicon acquired the entire issued share capital of Lonrho Aviation Limited (Lonrho Aviation), which was the holding company for a Pan-African airline, Fly540. This acquisition saved Rubicon from the regulatory and administrative efforts of starting a new airline from scratch. During the same period, Rubicon also entered into an agreement with Sir Stelios Haji-Ioannou's easyGroup to license the Fastjet brand from easyGroup, in return giving easyGroup a stake in the airline. Subsequently, Rubicon changed its name to Fastjet Plc in August 2012. Initially, the Fastjet group comprised of Fly 540’s businesses in Tanzania, Kenya, Angola and Ghana. While Fly 540 Tanzania was replaced by fastjet Tanzania in 2012, the remaining businesses continued to operate under the Fly 540 brand. This is where Fastjet’s troubles began; Fly 540 as a whole struggled throughout its existence under Fastjet and this has had adverse negative impact on Fastjet’s fundamentals. Ultimately, fastjet decided to put all the three businesses of Fly 540 under restructuring and suspended their operations. Fastjet has since disposed of Fly 540 Kenya, while its Ghana and Angola operations are being held for sale. It remains to be seen though how positively this would impact fastjet’s fundamentals.
Macro issues also contributed to fastjet’s woes
The airline also had to face several external challenges that further aggravated its losses. Macroeconomic and socio-political challenges in Tanzania led to falling demand for air traffic that resulted in lower than expected load factors. While the African aviation market has potential, it is not the easiest market to operate in. The continent doesn’t yet have an open skies agreement, which creates several regulatory hurdles for airlines wanting to fly across countries in Africa. It is not surprising that Africa remains the weakest region for aviation among all the continents. According to IATA, African airlines collectively posted a net loss during 2014 and 2015 at a time when all other regions experienced record breaking profitability. And, even 2016 is expected to be a challenging year for the African aviation market. Ishka believes that the challenging macroeconomic environment makes it even more difficult for Fastjet to improve its top line.
Some positive steps
The airline has recently taken some positive steps. The incoming CEO, Nico Bezuidenhout, who will join the airline on 1st August, 2016 has previously led South African Airways’ LCC unit, Mango since its inception in 2006. Mango is among the select few LCCs in Africa that have recorded profits.
Both, the incoming CEO and Chairman, Colin Child, have already identified areas of restructuring and will be reviewing the network and fleet to align them more with market demand.
Fleet and lessors (As of July 2016, fastjet operated 5 A319s).
The incoming CEO has also rightly identified that its fleet of A319s is unsuitable for the market it operates in and that the airline is open to migrating to a smaller regional fleet type. We see this as a welcome step towards cutting costs. Smaller aircraft would definitely be cheaper to lease and would also optimise the airline’s capacity in-line with the actual demand. This could invariably lead to better fleet utilisation and therefore greater efficiency. Separately, the management is also considering shifting its headquarters from the UK to an African base which would also help in reducing operational costs.
Fastjet’s future depends a lot on its ability to raise funds from its shareholders. In the absence of funding from shareholders, the airline would struggle to pay for its day to day expenses and would eventually have to shut shop. The airline would also find it difficult to borrow money as financiers would not be keen on lending to a company with such weak fundamentals. Even if it manages to get a working capital loan, the cost of financing would be extremely expensive adding further pressure on the airline’s already weak bottom line. Separately, fastjet will also struggle if it fails to find lessors for the smaller fleet type. Lessors might be wary of leasing to an airline that is struggling to generate any positive cash flow and where the chance of default is high. Under current demand scenario, the A319s would remain under-utilized and this would also make it difficult for the airline to lower its cost base.
Ishka View
There is significant potential for low-cost travel in Africa, however, it is a difficult market to operate in. The lack of an open-skies agreement between African countries and regulatory hurdles creates an additional level of challenge for the airline. While Fastjet was correct in identifying and targeting the opportunity, the airline has failed to control its cost base - the most critical element of a low-cost air travel business. In addition, being based in the UK while all its operations are in Africa, not only created operational challenges for the management and staff, but also contributed to higher operational costs. And, macroeconomic and other socio-political challenges further dented the airline’s top-line. We strongly believe that unless fastjet takes immediate steps to reduce its operating costs and to restructure its network and fleet, the airline will struggle to maintain its existence.
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