Published in June 2016 issue
By Jeff Kriendler
The infectious smile of the Flight Attendant (FA), warming the threshold to welcome the over 300 passengers boarding our flight from Munich (MUC) to Johannesburg (JNB), and the high spirits of the entire flight service crew did not provide any clue of the serious challenges to its future currently being faced by South African Airways (SA).
Being referred to as ‘hapless and helpless’, ‘debt-ridden’, a ‘dinosaur’, and technically insolvent, and with its former CFO frankly admitting that the balance sheet was ‘very weak’, this venerable carrier, which once flew to far-flung corners of the globe, has been retrenching to reflect the sober reality of its financial position and the macroeconomics of the global airline industry.
State-owned South African Airways has the dual mandate of sustaining itself commercially while being a socioeconomic engine for the country. These two objectives are often in direct conflict, with prestige and job preservation prevailing over profits and efficiencies.
Largely a victim of geographic isolation, competitive pressures, poor liquidity, corruption, a weak home currency, an aging long-haul fleet, and revolvingdoor management turnover—all faced while staggering through South Africa’s sputtering economy—the airline has finally embarked on a ‘long-term turnaround strategy’ (LTTS). “This is a plan created by the business, for the business, with clear milestones set to achieve stability and, ultimately, commercial sustainability,” Chairwoman Dudu Myeni wrote in Sawubona, the airline’s inflight magazine. “The LTTS is likely the most important document ever crafted at SA.”
What she failed to mention was that it was the carrier’s 13th plan in the past decade, a period of government meddling and senior management upheaval which has resulted in seven CEO changes in the past four years and the recent resignations of its Chief Financial and Chief Commercial Officers.
Leadership under pressure
South African is the leading carrier in Africa, serving 70 destinations in partnership with SA Express (XZ), SA Airlink (4Z), and the airline’s successful low-cost carrier, Mango (JE). It operates nine intercontinental routes from its JNB hub, which has been shrinking over the past decade. SA offers 29 destinations across the African continent and operates over 550 weekly flights within South Africa. The airline connects its homeland to major tourism partners and, in doing so, supports over 33,000 jobs in the country’s tourism industry, contributing US$900 million, or around 3%, to the country’s GDP every year. Approximately 40% of all passengers and more than 50% of all cargo within and to South Africa last year was carried by the South African Airways Group.
SA has a market-leading 22% of total seat capacity in South Africa, while Mango’s market share has grown to about 18%. On the other hand, SA’s two regional partners, Airlink and government-owned SA Express, together account for about 16% of the market, giving South African Airways Group the control of over 56% of the total local market.
Mango has proved to be a very efficient carrier. With a fleet of 11 Boeing 737-800s, the carrier handles an average 4,500 passengers per employee, versus the 700 passengers per employee figure of SA. The bloated 11,500 employee head count is now the target of cost-cutting and efficiency programs.
The carrier is being pressured by competition both at home and abroad. European legacy carriers, eyeing South Africa as a lucrative market, have been increasing capacity on their routes to JNB and Cape Town (CPT). Especially aggressive in routes to South Africa are Turkish Airlines (TK) (Airways, June 2015) and the Middle East Big Three (MEB3), Emirates (EK), Etihad (EY), and Qatar Airways (QR) (Airways, October 2015), four network carriers that have mastered the long-haul inter-connectivity of the globe. EK flies to over 20 points in Africa from its Dubai (DXB) hub. Turkish serves 50 African destinations. On the domestic landscape, as in so many other such markets around the world, LCCs have grown substantially, causing price pressures and, in some cases, overcapacity. Yet, budget travelers represent only 0.7% of total traffic compared to 23.6% in North America, 27.3% in Asia-Pacific and 37.7% in Europe.
Partnerships: route optimization
For many years, during the country’s racist apartheid regime, SA was an isolated airline; denied landing rights in African countries and forbidden to fly over their air spaces. It was forced to fly around the bulge of Africa—a considerable detour on direct great circle routings. Despite those obstacles, the airline flew to Australia, the United States, and many points in South America, Europe, and Asia, largely using the longest-haul aircraft available, the Boeing 747 and, particularly, its 747SP variant.
In recent years, due to severe operating losses, SA has radically cut its international route network. Yet, with apartheid gone, the airline now serves some 30 countries in Africa, which has become the company’s most profitable continent.
At one point, SA served many European points, such as Milan (MXP), Copenhagen (CPH), Manchester (MAN), Hamburg (HAM), and Paris (CDG). However, in a turn to profitability of its long-haul network, the airline has opted to shrink its European destinations to London (LHR), Frankfurt (FRA), and Munich (MUC). Other key international points—including Bangkok (BKK), Taipei (TPE), Singapore (SIN), and Buenos Aires (EZE)—are also gone. SA also suspended its service to Beijing (PEK)— choosing instead to operate code-share services with Air China (CA)—and to Mumbai (BOM), with a codeshare with Etihad over its hub in Abu Dhabi (AUH), whence the Gulf carrier operates throughout the Middle East. However, this EY codeshare was put to an end in March 2016 after poor results.
Nico Bezuidenhout, who has twice served as SA’s acting CEO, refers to the importance of ‘route optimization’.
“We often speak about the geographic disadvantage of being at the bottom tip of the African continent,” he told Airways. “For end-ofhemisphere airlines, the importance of partnerships cannot be overestimated and we will collaborate closely with our existing and other possible future partners on exploring aspects of key comercial value to South African Airways.”
Bezuidenhout, CEO of Mango since 2006, was first brought in as acting SA CEO in early 2013. He was called back to duty in October 2014, when the incumbent CEO, Monwabisi Kalawe, was suspended amid charges of corruption, invasion of privacy, and of falsely accusing the Chairwoman of bribery. In May 2015, Bezuidenhout resigned and returned to Mango. His leadership is well regarded as, under his business plan, Mango was able to cope with the impact of the global financial crisis. After only two years since its founding, in 2006, Mango achieved profitability, and is today one of South Africa’s most recognized brands.
“South African Airways has been able to substantially improve its operating performance by suspending flights between South Africa and both China and India while still participating in revenue generation,” Bezuidenhout said.
At the urging of the South African government, connectivity between South Africa and major BRICS member states (Brazil, Russia, India, China, and South Africa) has been increased substantially. SA has played an essential role by providing key links to such countries, mostly moved by foreign policy gestures rather than actual market needs, with negative financial consequences.
Special focus on Africa
Last July, the airline added four weekly flights between Accra, Ghana (ACC), and Washington (IAD). These Airbus A330-200 flights were also operated on a daily basis via Dakar, Senegal (DKR), but have now been reduced to three weekly rotations. SA has full traffic rights between Accra and Washington. When finalized, an interline agreement with Africa World Airlines (AW) provides SA customers from Washington and JNB with connections through ACC to other destinations in Ghana, such as Kumasi (KMS), Takoradi (TKD), and Tamale (TML), as well as to Lagos, Nigeria (LOS). From Washington, SA offers convenient connections to over 50 markets in the US and Canada through its Star Alliance partner United Airlines (UA), JetBlue (B6) and Virgin America (VX).
South African says it has increased frequencies to key African destinations by nearly 25% to meet soaring demand between JNB and Maputo, Mozambique (MPM); Harare, Zimbabwe (HRE); and Kinshasa, Congo (FIH). Marc Cavaliere, SA’s Executive Vice President for the Americas, says that forward bookings for the Washington DC-Accra flights are strong, and the route holds great potential. SA also recently inaugurated three weekly flights from JNB to Abuja, Nigeria (ABV).
The carrier has also been in talks with Cathay Pacific (CX) (Airways, May 2015) about a joint venture between JNB and Hong Kong (HKG). This would provide the South African carrier with access to a large number of points in Asia, including Japan—a good opportunity, since Malaysia Airlines (MH), Thai Airways (TG), and Korean Air (KE) all ceased operations to Africa in recent years. SA is also in talks with Qantas (QF) to partner on a QF service from Sydney (SYD) to JNB. In North America, at JFK, SA is code sharing with B6, connecting with flights from Johannesburg.
For all that, Bezuidenhout says that SA’s focus will be route expansion within Africa, providing the implementation of the Yamoussoukro Decision moves forward. This 1999 Decision, named after a city in the Ivory Coast, saw 44 African countries agreeing to establish full liberalization of the intra-African air transport market, with free exercise of first, second, third, fourth and fifth rights for passenger and freight services.
SA has a crucial role to play in driving economic development in Africa by increasing aviation traffic, Bezuidenhout says. “Our goal is to increase revenue in the region by 30% in the next 12 months. Africa is a huge potential market for aviation and, as Africa’s legacy carrier, South African Airways wants to see the continent contribute to more than its current share of global aviation.”
Refreshing the Fleet
The airline’s fleet currently numbers 54 aircraft, mostly Airbus types, including nine A340-600s and eight A340-300s, which are used on long-haul flights, and six A330-200s deployed on mediumto- long-haul operations. The carrier’s narrow-body fleet includes nine Boeing 737-800s, 12 Airbus A320-200s and eight A319-100s, all used on domestic and regional services in sub-Sahara Africa. The airline also operates two Boeing 737-300 freighters.
South African Airways has a current order for 20 A320s. These were bought marginally above the market Price in 2010 and the deal was supposedly canceled, according to SA, but disputed by Airbus. The first 10 A320s have been delivered, but their inflated prices forced SA to take an impairment charge of $115 million. The carrier has received Airbus’ approval to swap the remaining 10 A320s for five A330s, set for delivery in 2016 and 2017.
“The A320 deal has hurt us in two ways,” said Bezuidenhout. “It absorbed liquidity when we needed the cash and we overpaid on the market price; and therefore we are paying the price in terms of solvency. The A320 is a great aircraft— but it’s just not financially great for us. No one else on the African continent currently operates a newer version of the A320 than we do.”
The drop in jet fuel prices has given the airline’s fleet of A340s new life and SA has renegotiated an extension of leases on some of these aircraft at reduced rates. The airline will soon turn its focus to acquiring new generation wide-bodied aircraft, but the need is not immediate, as some of the A340 fleet can continue to operate until 2020—a risk if oil prices spike in the future.
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Service quality: Maintained
Belying negative media coverage that constantly questions the airline’s liability, SA has received SkyTrax’s 4-star rating for 14 consecutive years as Africa’s best airline, as well as best service staff, which excels in warm cabin hospitality. It publishes a world-class inflight magazine and has a top frequent flyer program, but its IFE product and Business Class seats are falling behind when compared to its long-haul competitors.
As stability and funding allow, SA may make service enhancements. Its dilemma is whether to upgrade its existing A340 fleet now or wait to acquire new longhaul wide-bodies when funding is available.
Cost reduction plans
Along with other cost compressions, such as supply chain contract renegotiations, SA has begun to cut 10.5% of its staff through early retirements and voluntary severance packages. The airline’s overall target is to reduce costs by $175 million.
The carrier is battling headwinds, however, on the currency front. Any savings made have been offset by sharp declines in the value of the rand. Nearly 60% of all the airline’s costs is priced in foreign currencies, while foreign revenues represent only 40% of gross income, Bezuidenhout noted. “This disparity against international competitors places a handicap on our business, in that countries with stronger currencies are less affected by foreign exchange fluctuations,” he said.
IATA says that Africa has reported the weakest geographic financial results in the past two years, with profits representing only $1.59 per passenger. Although break-even load factors are relatively low, yields are a little higher than average, and costs are lower, few airlines in the region are able to achieve adequate load factors. In 2013, 2014 and 2015, those were the lowest of any global region: a scant 56%.
What Africa needs, according to the IATA, is a liberalization of restrictions on intra-African connectivity. If the skies were open among the 12 largest passenger generating countries in Africa, IATA says, there would be a benefit of $1.2 billion and 155,000 new jobs. The continent’s governments also must speed up the implementation of global safety standards.
“Safety continues to be a challenge for Africa,” said Tony Tyler, IATA’s chairman. “The fact that the region experienced no jet-hull loss accidents last year is real progress. However, the poor performance on turbo props demonstrates that significant challenges remain.”
Challenges… and great potential
The biggest risks facing South Africa as a nation are corruption, unemployment, an ailing infrastructure, and political and social instability. Some economists are optimistic about the future of Africa because it has a young population, abundant natural resources, and a growing democracy. They say Africa is stable, and provides a faster and more exciting return on investment as infrastructure and energy developments are completed.
South Africa’s economy is currently under significant pressure. “Local currency volatility and weakening has resulted in significant cost pressures to the national carrier and has resulted in higher operating costs for the airline as the 50% decline in the value of the rand has negated the drop in the Price of jet fuel, ” said Craig Parker, an analyst with Frost Company, based in Cape Town. “The current economic climate is not set to change rapidly due to weak demand for exports of South African products to Europe and internal pressures resulting from labor instability and corruption scandals.
“The high unemployment rate (estimated at 26%—nearly 50% for the younger population) coupled with a large number of illegal immigrants from other African countries has created frustrations from South African citizens who see the foreigners as coming in to steal jobs,” Parker added.
Domestic journeys in South Africa are expected to increase by just over 10 million between now and 2034, leaving it among the world’s top-20 largest domestic markets. “South Africa remains the largest aviation market in Africa and there is great interest in market entry, despite it being a high-cost aviation environment impacted by the high rate of exchange on Africa’s weak currencies,” said Chris Zweigenthal, chief executive officer of the Airlines Association of Southern Africa.
He says, “The story of African airlines remains one of challenge, massive potential and countless opportunities. Frustratingly, with some exceptions, Africa has failed to reap the benefits presented by these opportunities. With strong political will and leadership, good intent and a joint industry plan, it is still possible for Africa’s airlines to thrive within this highly competitive industry.”
Transportation is playing an increasingly prominent role in the economy of Africa. But, compared to other continents, the infrastructure is outdated with frequent blackouts, which put great restraints on economic development. Ill-maintained roads lead to high transport costs. Africa’s aviation industry is beset by a wide range of other issues that impede growth, including strong state protectionism, a lack of desire to liberalize, high taxes and charges, and an underperforming, yet improved safety record.
Further global events, such as the drop in oil prices and the slowing pace of China’s economy, will reduce the sub-Saharan growth rate this year to its lowest in two decades. Economic output is pegged to grow 4% across the region this year, below its historic average of 4.4%. The region has also been hurt by concerns about Ebola, terrorism, and attacks on foreigners.
Despite these impediments, the continent’s airlines are pursuing aggressive expansion plans to accommodate higher demand for air travel from a growing middle class.
China’s economic influence in Africa is booming, its share in Africa’s total trade rising to 13%, from 3% a decade ago. Attracted by the continent’s abundant natural resources, China now imports onethird of its oil from the region. Chinese infrastructure investments in Africa were first focused on roads and railways but are now turning to airports. The Chinese have built airports in Kenya, Nigeria, and the Republic of Congo. HGA, the holding company that owns Hainan Airlines (HU), is considering investing in African airlines.
There are reasons to be optimistic about Africa. It is projected to have the biggest population increase globally over the next 20 years, and for the population to double to 2.4 billion by 2050. By 2040, half of the world’s population under the age of 24 will live on the continent. Analysts say that Africa is where South African Airways has the biggest opportunities, as profits on long-haul intercontinental flying will continue to be challenging.
Some observers believe that SA should be privatized because “all the decisions a good manager would take are not acceptable politically,” as Harry Markman, a Free Market Foundation executive committee member, puts it. Foundation Director Temba A. Nolutshungu adds: “Governments should stop rationalizing state involvement in the airline industry by using the excuse that state-owned airlines are of strategic importance. This is an empty argument. Freely competing private airlines provide better services at lower cost, so what is strategic about a state-owned airline?”
Many say that, to be ultimately successful, South African Airways must have the complete support of its government and the flexibility to respond to changes in the marketplace. There is a long history of meddling that must end if the airline is to be profitable. Eventually, the airline’s success will depend on maintaining a strong management team that can work closely with its governmental owners to respond to the competitive pressures it will face.