South African Airways continues to bleed

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The embattled South African Airways (SAA) continues to lose money, and has reported an operational loss [EBITDA (earnings before interest, taxes, depreciation and amortiSation)] of R374 million reported (R425 million FY 2012/13). Cost containment during the financial year yielded sustainable savings of R453 million.

The SAA Group’s domestic operations remain profitable with 10 per cent growth in its profit contribution from R722 million to R791 million. Regionally, African routes performed positively with a 17 per cent increase from R648 million to R761 million. SAA’s long-haul intercontinental operations recorded an increased loss from R1,3 billion in the previous financial year (2012/13) to R1,6 billion in losses reported for the 2013/2014 financial year. SAA has reduced its cost per

available seat kilometre (CASK) by 5 per cent from 7.05 US cents to 6.19 US cents during the period in review.The volatility of the Rand has seen a decline in value of over 34 per cent during the 2013/14 financial year and has placed local airlines at a disadvantage considering the fact that nearly 60 per cent of all input costs are priced in foreign currency while forex revenues represent only 40 per cent of gross income. The disparity when measured against international competitors places the business in a challenging competitive position; an increase of 2 per cent in overall input costs impacted the bottom line positively. During the period in review SAA realised net hedging gains of R76 million compared to hedging losses of R84 million incurred in the previous financial year.

Another significant cost included in the financial statements for the period in review is the impairment relating to aircraft. A critical element of SAA’s long-term turnaround strategy (LTTS) is the future replacement of its existing wide-body fleet with new generation, more fuel-efficient twin-engine aircraft. In this regard, the seven wide-body aircraft owned by SAA had to be revalued in terms of International Financial Reporting Standards (IFRS) to take into account their anticipated remaining useful life. This revaluation resulted in an impairment of R782 million, as well as an additional R192 million write down on related spares and inventory, which are reflected in the statements.

Further impairments were recognised relating to the delivery of four new A320 aircraft. These form part of a legacy agreement for 20 aircraft, dating from 2002, which was renegotiated in 2009. However, the contract provides for annual escalations that resulted in the purchase price exceeding the market value at date of

delivery—thus leading to a further impairment of R369 million. Unfortunately, similar impairments are expected on future deliveries on this contract. SAA’s

remaining capital commitment for these purchases is R822 million.

SAA has been reliant on guarantees from its shareholder (the South African Government) for several years and the delay in the release of the financial statements for the 2013/14 financial year is directly related to the continued weakness of the company’s balance sheet and due to the company being technically insolvent. Currently, guarantees total R14,3 billion (R6,4 billion in December 2014 and R7,9 billion in additional guarantees prior).

It is the intent of the Board (reconstituted in October 2014) and SAA management to reduce the reliance on guarantees and return the business to relative stability. The lack of implementation of several critical aspects of the Long-Term Turnaround Strategy, during the latter half of the period in review, has resulted in the need for a further guarantee (as issued in December 2014) to ensure the continued going concern status of SAA over the short-term.

A full review of the LTTS is also underway to ensure revalidation in line with the current needs of the business given SAA’s failure to adequately implement the plan. The shareholder and newly constituted board have made it clear to management that the 90-Day Action Plan’s primary outcome must be the resumption of LTTS implementation. The 90-Day Action Plan period ends on 24 March 2015, whereafter implementation of a revalidated LTTS will be resumed, albeit

trailing 16 months behind schedule.Under the 90-Day Action Plan, guided by unimplemented aspects of the LTTS, SAA has reconfigured loss making aspects of its intercontinental network as well as implemented mitigating actions to minimise customer inconvenience along with considered potential commercial gains.

• SAA will optimise its intercontinental network with network expansion through code sharing already growing SAA’s network.
• The introduction of flights between Johannesburg and Abu Dhabi (announced in December 2014) with substantial SAA-coded network end point growth in the Asia-Pacific region through its deepened commercial relationship with Etihad Airways. The route is expected to attract inbound traffic from several destinations within its geographic reach while also adding a large number of additional outbound destinations via the Middle-Eastern hub.
• SAA has announced an expanded partnership with Air China (early December 2014), opening up a host of new possibilities to improve the connectivity between southern Africa and China.
• SAA has increased regional frequencies between Johannesburg and several key, high volume regional destinations including Mauritius, Zambia, Zimbabwe and Mozambique among others.
• A full contract review is under way with onerous agreements being examined. It includes all supplier agreements, including a review of aircraft leasing

contractual positions.

• SAA procurement has been mandated to realise a further 10–15 per cent benefit on existing and new supplier agreements.
• An immediate freeze on headcount was implemented with a moratorium on any new appointments.
• Members of the executive management team were tasked to manage the full implementation of the 90-Day Action Plan, to correct LTTS implementation failures. They meet twice weekly to review progress and a weekly oversight engagement is held with a National Treasury Technical Team
• Critical LTTS interventions are contained in the 90-Day Action Plan, with a LTTS Executive Steering Committee formed to more closely monitor implementation throughout the business.
• Through the newly issued guarantee, SAA has retained its going-concern status and ensured short-term solvency and liquidity challenges.
• Full implementation of the 90-Day Action Plan, leading into LTTS implementation, will return the company to relative stability and ultimately sustainability in

the medium to long term.

• While the former shareholder Minister signaled that the Government would contemplate a Strategic Equity Partner for SAA, the notion is in its infancy and SAA management will present several future-funding options to the Board and, in turn, the shareholder by the end of the 90-Day Action Plan period for

consideration.

• An immediate review of all contractual burdens and governance implications or defects within the legal framework of the company is well underway. This

includes the review of onerous agreements, correction thereof and other matters that impact the framing of remedial activity; the re-establishment of

foundation laying for LTTS implementation within a tight governance environment.

• The examination of all assets in the business and reorganisation thereof in terms of the requirements of the LTTS is well underway and on track.
• SAA has commenced the process of re-engineering its internal and external communication efforts to effectively communicate with all direct and indirect

stakeholders and South African citizens, particularly with reference to the implementation of the 90-Day Action Plan as well as the LTTS