South African Express Airways on 2014/15 Annual Report

Meeting report

SA Express Airways on its 2014/15 Annual Report
Mr George Mothema, Board Chairperson, SA Express (SAX), introduced board member, Mr Trevor Abrahams, who chaired the SAX board committee on Aviation Safety, Security and Strategy. He had invited Mr Abrahams to assist on any queries the Committee had on the technicalities on Aircraft on Ground (AOG).

Mr Mothema said that the first presentation by the CEO dealt with the performance of SAX against its agreed shareholder compact, the austerity measures and SAX’s strategy implementation update of SAX 20:20 Vision. The second section would deal with financial performance as presented by the CFO.

Mr Inathi Ntshanga, SAX CEO, said the airline was presenting its performance for the financial year that ended in March 2015. He drew attention to a photograph of a group of cadets recently graduated from SAX’s pilot academy. They were full time pilots from the beginning of 2016. He said SAX had trebled its turnover from just under R700 million ten years ago, to R2.6 billion in 2015. SA Express had achieved 27 of 44 (61%) indicators for 2014/15.

Between November 2014 and January 2015, fuel prices had decreased considerably. However, jet fuel had not decreased at the same rate as fuel prices because it was dollar-rand denominated.  The increased competition which SAX had grappled with within its industry had been found to be unsustainable.

Financial Performance – Income Statement
Mr Mark Shelley, SAX CFO, said that SAX had moved from a loss of R10 221 383 in 2014 to a total loss R132 357 637 in 2015. The loss was a result of the depreciation line item and the fact that SAX had finally gotten to a place where the auditors had been happy with SAX’s closing balances on inventory and rotables. That spoke to some of the qualifications that Auditor-General South Africa (AGSA) had with SAX over the past few years and the restatement of accounts. The impairment of spares item contributed greatly to that total loss. Fortunately though, SAX would no longer have an opening balance qualification by AGSA, as the closing balance issue had been sorted out at the close of 2014/15. On fuel prices, he noted that the differential between Brent crude and jet fuel. Brent had come down by 54% where the comparable reduction in jet fuel was down by only 19%.

Financial Performance – Balance Sheet   
Mr Shelley said that SAX had managed to keep its equity positive though not by a large margin. That indicated SAX’s weak balance sheet as it had very little asset value due to its aging aircraft.

Key Issues relating to Balance Sheet
Mr Ntshanga speaking to the undercapitalization of SAX said in 1994 when the airline was established, it had been founded through 100% gearing. That meant all the money for establishment was borrowed and the entire fleet was not owned by SAX. Those founders were also different from Government, therefore when Transnet bought SAX, the company had always been undercapitalized.

He said that it was not comfortable always working on the back foot. One way of getting out of that was through a good cash injection. Another solution could be retained earnings improving year on year for a good period of time.

Cost Containment 2016/2017
Mr Ntshanga said that if a comparison could be done on similar time periods in financial years 2014/15 and 2015/16, SAX believed that the austerity measures had been turning the company around. In September 2013/14, after the first six months of that year, SAX had generated a loss of R118 million. The austerity measures were then implemented and the total loss generated was R138 million. From April to September 2015 SAX had generated a profit of R11 million, therefore when taking the R118 together with R11 million, SAX had generated a negative to positive turnaround of R127 million. In November 2015, that profit had risen to R25 million.

Mr Ntshanga said that the aviation industry was going through a turbulent period with South Africa also going through an economic downturn. Therefore companies had devised different ways of cost savings including less business travel for executives which meant less revenue for airlines. On top of that, start-up airlines were waging a price war which was not sustainable and with their closure, the industry was left with having to manage those competitive prices.

Discussion
Dr Z Luyenge (ANC) said that the transformation of SAX from its establishment to date was commendable. However, the business had to grow - therefore how possible was it for SAX to not compete with South African Airways (SAA) and Mango airlines?  Did SAX have a scarce skills retention strategy? Did SAX have an inventory holding policy that was informed by its own asset management policy? The question was informed by a concern about the unavoidability of SAX fleet aging and his wish to see the company with a new fleet. 

Ms N Mazzone (DA) appreciated the SAX board appearing before the Committee as it was concerned about the SAX qualified audit. There had been some explanations as to why that had occurred and that the austerity measures were producing some positive results, certainly SAX’s sister airlines could learn a lot from SAX. There was still a huge government guarantee going to SAX; was there any indication as to when the country could expect SAX to be self-sustaining without a state guarantee? Competition in the industry could be a bad thing for the company but it certainly was not for the consumers. She said SAX had to improve its communication strategy when there were delays as citizens tweeted her when there were delays without any reason given.  That was also one of the reasons that SAX’s reputation was suffering. She noticed that there were reductions in airport charges by the Airports Company South Africa (ACSA). Previously the Committee had been informed that SAX would be negotiating a deal on the reduction of those very high charges, had the negotiations occurred? On the jet fuel prices that had not decreased as expected, was SAX negotiating prices separately from SAA and Mango? There had been a lot of media reports about political influence over SAX routes. Was there any truth to those reports, especially about keeping non-profitable routes? On the much needed cash injection that SAX needed to capitalize its business were there any public/private partnerships that SAX was looking into?

Ms T Stander (DA) commented that as SAX was struggling to retain its scarce skills, how was it attracting these skills? Possibly SAX could pilot a scarce-subjects learners programme from previously disadvantaged schools with bursary incentives from as early as grade 8 to 12, so that by the time they finished the aviation qualification, SAX could contract these graduates into an in-service period. Could SAX specify how much exactly the government guarantees were and what impact they had on the business? Loyalty was not always based on pricing of tickets, safety was also a factor, what other alternatives did SAX have in place to increase brand loyalty.

Mr M Tseli (ANC) said that the SAX total loss of R132 million in 2013/14 was quite concerning, could SAX clarify how it had saved R512 million over the past three years if there was also that loss reported. The company could certainly do more on reducing irregular and wasteful expenditure, though what had been done was commendable. What had been done with officials found to be responsible for that wasteful expenditure? On the 25 funding options submitted to the shareholder, what had been the response from the shareholder so far? What impact did the salary and training freezes have on SAX operations going forward, since the implementation of the austerity measures? To what extent were labour unions involved in the decisions to do both and in avoiding labour disputes? On the termination of loss-making routes, where there no alternatives to doing that, as one would understand that that was a result of heightened competition? He was concerned that SAX would run out of routes as competition was not going to lessen.

Ms Z Rantho (ANC) said as commendable as the SAX youth programmes were, did it have a plan to expand that programme to the most rural youth? On Ms Stander’s proposal about approaching disadvantaged high schools, had SAX approached any technical colleges in that regard so far? Were they across the country or only in Gauteng, and what was the intake annually?

Mr N Singh (IFP) asked how many airplanes SAX had and how old where they? What was the lifespan of each type of aircraft in its fleet? By when did SAX envisage that it would have to replace its fleet and how was it planning to manage that financially? It was noteworthy that there were 150 black pilots at SAX. However, what was the total number of pilots at SAX? Since Durban-Cape Town had been billed as a loss making route, SAX had not phased it out yet; was that going to remain so? On cost containment, what deal had SAX negotiated with ACSA for that decrease in airport costs? Mr Singh also wondered if SAX’s loss of passengers had not been related to its savings on catering. What had given rise to a savings in maintenance and repairs?

Mr N Kwankwa (UDM) said he found it contradictory that SAX had achieved 61% of its targets in its shareholder compact but had regressive performance indicators especially on financial controls and qualified audit opinions. Moreover the targets in the shareholder compact were difficult to measure as members did not know what they were. What were they in broad terms and how did they contribute towards the strategic direction of SAX? He was certain that there was always a correlation between financial performance and financial controls. Therefore he understood and shared senior management’s frustration as to the reasons they had been getting qualified audits until 2014/15. 

On booking a flight with an agent, the confirmed ticket would have in its breakdown a priced catering item. He had been surprised that although he had been charged R100 on two separate occasions on SAX, the food amounted to a soft drink and nuts. Who was the payment to, between the agent and SAX? On the Cape Town to East London route there were repeated groundings and delays of SAX flights, generally because of technical faults.  He understood that was the challenge of an aging fleet and perhaps that was why SAX had been losing business to competitors. Had the salary freezes not affected staff morale and how was SAX then planning to attract and retain talent if it was cutting down on training as well? How high were the gearing ratios of SAX and how did the company intend to turn them around.

In response, Mr Mothema referred to page 11 of the presentation about the aging fleet. The biggest challenge was around the CRJ200, its components, rotables and the lead time in getting components. The ability for the business to overcome some of its challenges revolved around its fleet strategy, which was work in progress.  There was a business case around the replacement of SAX’s aging fleet but that was something the airline could share in future with the Committee. Certainly the work was about finding a way around the aircraft challenges, funding mechanisms and to engage SAX’s shareholder on how best those could be overcome.

On routing, there was no political influence as the board simply requested management to submit a profitability outlook. From then on, a business case would be developed and then the board would have to argue that case to its shareholder, especially if the proposal was to terminate a route. Moreover a termination did not mean the route would be closed forever.

Mr Trevor Abrahams referred members to page 11 again where the type and age of each aircraft was listed. He said that the age of an aircraft did not necessarily mean a safety-compromised aircraft. There was a very detailed programme in the aviation industry on maintaining airworthiness of aircraft. Older aircraft, however, introduced a heavy maintenance burden which was where the cost impact was felt, and the availability of scheduled flights.  Secondly, there was more unscheduled maintenance occurring which was where when the crew detected anything, they were trained to return to their departure point. He said most commercial aircraft had triple systems but the level of safety demanded that when there was any safety concerns then that aircraft had to be returned to maintenance. SAX would certainly take on board the suggestions about communicating the reasons for delays as it was operating with old aircraft. On profitability and cheap pricing, Mr Abrahams said that caution had to be exercised as historically there had been a large reduction in cost that had come with deregulation globally that affected the cost of entry for new players. Competitive pricing could easily lead to one acquiring older aircraft where the capital costs were very low but that model was not sustainable.  That led to new entrants running cheap and grabbing the market but unsustainably so. For a few years that entrant would make a lot of money but then that was not competition on a comparable basis with airlines like SAX.

Mr Ntshanga said that SAX did have a retention and recruitment strategy that was bottom-fed, which meant continuous training of scarce skills. SAX recruitment programme was not only based in the big cities as it did partner with schools with programmes like Math genius and adopt a school where SAX promoted the learning of maths, geography and English which were the core subjects for its pilots. Moreover SAX also focused on disadvantaged top performers from rural schools where they would be taken to an aviation expo in Johannesburg from anywhere in the country. In the former Transkei SAX was in collaboration with Walter Sisulu University as well as the University of Johannesburg (UJ). In the aviation industry the Airlines Association of South Africa (AASA) had an aviation scholarship which SAX was championing

On the guarantees that SAX had, as of 2015 they were for five years and the company was planning to extend them for another four years. However, SAX still needed to address undercapitalization aside from those guarantees.

He emphasized that competition was good only if it was sustainable because if it came in and then disappeared again, it did that whilst destroying value for the remaining airlines. As recently as December 2015, SAX was called in to bail out stranded passengers from an entity that had gone bankrupt, and that was not the first time that had happened.

On communication he said that SAX had a twitter feed: SA Express@flySAExpress and an internal WhatsApp group to better its communication strategy.

Route termination was generally because of there being too much capacity on a certain route. Of the 26 original routes, SAX still flew 24 routes and that would not be a continuing trend. There were however, ring-fenced routes which would be borderline profitable but that was not politically motivated either.

On loyalty, SAX believed in the Frequency, Availability, Cost and Timing (FACT) principle. Frequency spoke to how frequently SAX flew particular routes and availability spoke to its belief that it had to use all means to ensure availability of scheduled flights. Timing and cost were simply about flying at the right times and appropriate costs. Generally, SAX flew between 6am and 9am where it also tried to fly where the peaks are to accommodate all passengers. It was also part of SAA’s Voyager program. The company also had a very strong network in its outstations like Bloemfontein, Kimberley and Richards Bay where business and communities knew the SAX staff.

On fruitless and wasteful expenditure, Mr Ntshanga said the bulk of that was not people wasting money but had to do with the interest payments the airline was paying because of its undercapitalization. Where it had been found that there had been dereliction of duty, proper disciplinary processes were followed.

On salary and training freezes, Mr Ntshanga said that SAX continuously monitored and communicated with its labour. As long as one set the expectations and communicated them upfront, people seemed to listen. The CEO had a quarterly staff briefing where the company talked about the numbers and where expectations where deliberated so that no surprises occurred. Senior management salaries were known by everyone in the company and that is how transparent SAX is.

SAX had about 200 pilots, approximately 50 of whom were black. The numbers did not include cadets which were still in training. Ten new pilots had graduated in December 2015 and were full time staff and what was good about the training was that SAX had partnered with Transport Education Training Authority (TETA) which had paid about R5 to R7 million for the training.

SAX was still discussing with the two provinces on whether to keep the Durban-Cape Town route because it had originally planned to pull out of the route. It wanted to keep the product but considerations had to be on whether it was using the most efficient aircraft, charging the appropriate airfare and other issues.

SAX had no deal at all with ACSA; the decrease in charges was due to SAX’s reduced flights. Over and above that was the fact that every five years ACSA negotiated with the aviation industry on those charges and even then the charges were regulated by the South African Civil Aviation Authority (SACAA). SAX was hoping for a negative increase by ACSA in airport charges as there had been no published information in 2015 about that matter.

In terms of components and rotables, SAX had had good negotiations with Pratt & Whitney, an American aerospace manufacturer with global service operations. That company had reduced a certain rate which it had been charging SAX monthly. SAX had also negotiated positively with Lufthansa where it would be paying reduced rates on maintenance.

Mr Ntshanga referred members to pages 79-82 of the SAX 2015 Annual Report where the shareholder compact with SAX’s performance against the objectives were written up. The underperformance had a lot to do with the strategic deliverables related to the Cost per Available Kilometre (CASK) analysis that SAX had not met. On the developmental indicators, SAX had achieved four out of seven because of its austerity measures.     

On catering, SAX had had to take a tough decision which it was reviewing on the offerings in-flight. However, cost containment required that that decision to cut catering remain in force until austerity measures were no longer required. 

SAX believed that the resolution of its fleet strategy would curtail the grounding of its flights and improve its on-time performance which was at 88% for 2015/16.

Mr Shelley said that SAX procured jet fuel through SAA and not separately. SAX had been approached to procure on its own as there could be some cost advantage to SAX buying its own jet fuel.

SAX had had to fly 8000 stranded passengers over December 2015 because of unsustainable fares by a competition airline which had folded.

He said that SAX’s average usage of its overdraft which was capped had been higher during 2015, compared to 2014. SAX was in a cycle of increased interest rates and that would result in an increase in finance costs year-on-year. Its guarantee would be foreseen based on its model amortising over the following four years which would mean an end to guarantees.

On profitability and the massive swing, that went back to valuation of inventory and SAX had been struggling to get a handle on its opening balance for inventory. It had been able to fix that as of 31 March 2015 such that it knew what its closing balance for that inventory was. All the differences had been accounted for and had been impaired where there was a need. That in total accounted for the swing of a written up inventory in 2014, where stuff that originally had not been in the system had been brought in, totalling a R149 million write up. In 2015 SAX had had to impair for what had not been in its inventory, especially for life-limited and time-expired parts. That accounted for the big swing from a R10 million to a R132 million loss.

As explained, the fruitless and wasteful expenditure was a result of interest charged by SAX’s foreign vendors where invoices would have been paid late as a result of disputes over the invoices.

Mr Shelley said that SAX’s recent audit opinion was better than it had been before, and although its controls were not a 100% there was an ongoing programme run by a task team which dealt with all the issues relating to inventory, rotables, and irregular expenditure potential. Asset policies had also been aligned to inventory holdings.

On catering, he said that SAX was looking at providing meals inclusive of the fare but with a different spread across what was available on the airplane, without increasing the cost base.

On the gearing ratio, SAX’s debt to equity was at about 5X, which meant it had five times more debt than equity. That was a factor of SAX’s legacy since establishment.

Mr Singh said the concern with the audit qualification was that the printed audit findings were after management letters were exchanged. What happened at that stage when the management letter was issued to the company’s management by the auditors? The Committee had to keep its finger on the pulse on the fleet strategy because, although he accepted that age was relative, at some stage, SAX would have to replace its fleet. The Committee knew about the debacle with SAA’s fleet strategy where outright purchase versus leasing had caused a big hullaballoo. Therefore, the Committee had to be taken into confidence at some stage about that strategy so that SAX would not find itself in a similar situation.

Mr Kwankwa said that target setting was a complex and difficult exercise because enough stretch and pull had to be built into a target.  It remained difficult for the Committee to determine whether there was enough stretch and pull built into SAX’s targets as there was no history to how there had been problems before and how SAX had dealt with them. If SAX did not attend to the aging fleet that was like standing in a bucket of water and trying to lift oneself out with the bucket handle. He repeated his question on who benefited from the meal charge, the agent or SAX?

Mr Mothema said that SAX agreed with the Committee that its fleet strategy needed urgent attention and the executive had a wish to take the Committee into confidence on that matter, particularly from a process point of view, without dealing with the actual contents of the strategy. SAX had gone through the first process with its shareholder and because of its weak balance sheet, replacement of fleet required funding. In principle, SAX had notified its shareholder that, because of its fleet challenges, it was exploring a business case for fleet replacement due to concerns around the CRJ200 airplanes. To echo Mr Abrahams, he said that because the aircraft had aged, that did not mean their airworthiness and safety were compromised. The Committee’s concerns were noted.

Mr Abrahams added that the billing for food was not from SAX, therefore the Committee possibly would have to find out from the agents where that money was going.

Mr Tseli said that he appreciated the fact the Department of Public Enterprises (DPE) did not speak at this meeting. However, there was no planned meeting with the Department about its entities so that some of the Committee’s concerns could be addressed. He was proposing that in future when DPE met with the Committee, it would commit to giving an overview about the status of its entities because he was personally not happy with DPE not having an opportunity to speak about SAX’s challenges.

Mr Kwankwa agreed with Mr Tseli, saying that, with DPE having no input although present at the meeting, made the Committee’s work more difficult. Certainly going forward, DPE would have to commit to giving input when its entities were coming to brief the Committee.

The DPE representatives noted the Committee’s concerns.

The Chairperson said the Committee was noting that there seemed to be a lack of focus from DPE, especially about attendance at a meeting where it would not give any input. 

Meeting adjourned.