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Kingfisher Airlines: What about the financials? - Outside View by Luke Verghese
 
 
Kingfisher Airlines: What about the financials?

The personal image stake

Having a personal jet or three is one thing, but running a commercial jet airline is a high wire trapeze act. This is one bitter lesson that Vijay Mallya must have come to realize, much to his chagrin, at some point of time into the game. To add to its troubles it even affected a reverse merger with Deccan Aviation, which was scraping the bottom of the barrel. But to make a long story short, given the big ticket personal image stakes involved, one has to now soldier on, and see how best to make of it. However, if Kingfisher beer has got some additional mileage from the branding of this enterprise, then atleast some of the debt has been repaid.

At the top of the heap

The company took corporate wings some 15 year ago, but commenced scheduled airline operations in August 2003. It must today be ruing the decision to go the whole hog, though the directors’ report talks up only the plus points of the enterprise. In less than seven short years it has become India’s single largest domestic carrier by passengers flown, and the number of cities that it covers. The airline continues to enjoy market leadership, with a market share of just under 23%. It makes do with a fleet strength of 68 aircraft with a route network covering 63 domestic, and 7 international destinations. Twelve of the aircraft are owned under finance leases while 56 are held under operating leases. The essential difference here is that in a financial lease, the lessee, (Kingfisher), gets to book the aircraft in its books, and claim depreciation, while in an operating lease it is a pure rental operation. Quite obviously it prefers to claim the latter operational mode concept. It also continues to be India's only Five Star Airline rated by Skytrax for 3 years in a row. The front page of the annual report is also bedecked with all the medals of honor that it has won. If the company is on all systems go mode, what then ails this company?

What the auditors have to say

Before we get into the nitty gritty, have a 'dekho' at what the auditor's have to say about the financial health of the company. The auditor's state, and I quote-'the Company's accumulated losses at the end of the financial year were more than 50% of its net worth. The company has incurred cash losses during the financial year and in the immediately preceding financial year'. For the matter of record, the accumulated book loss at end March 2010 is Rs 43 bn (Rs 25.7 bn.) Very cleverly the report does not state how much more than 50% of the net worth the losses are. And if all the accounting changes that it initiated, based on expert opinion is also taken into account, then the accumulated losses at year end, relative to net worth, would be substantially higher. The question that also arises is how 'expert' outside opinion can be superior to that of the accounting guidelines laid down by the Institute of Chartered Accountants of India (ICAI), as regards the treatment of incomes and expenses? What then is the sanctity of this apex body? But, let that be. Besides, the dressing up of accounts can only provide temporary reprieve. The point here is what is the longer term plan to get out of the rut? The company appears to have none, going by its continued tepid financials.

Another note states---'we report that the funds raised on short term basis to an aggregate extent of Rs 42 bn has been used for long term investment as at March 31, 2010'. This is a cardinal sin in accounting parlance, as in reality, long term and short term have diametrically opposite meanings. When the short term debts come up for payment, it will be impossible to liquidate the long term investments relative to these borrowings (which invariably constitute revenue earning assets) and retire the debt. Yet another note states, and this is where it raises the hairs on your spine - 'undisputed amounts payable in respect of provident fund, tax deducted at source, professional tax, fringe benefit tax to the tune of Rs 2.9 bn, were outstanding for a period of more than 6 months, from the date on which it became payable'. To round up the picture here goes another note - 'the company has defaulted in repayment of loans and interest to banks and financial institutions. Overdue installments, including dues on interest as at end March 2010 amounted to Rs 2 bn and Rs 816 m respectively'. In other words, it has muddied itself with just about every other financial delinquency that one can throw at a company. Actually the operations of this company are a lot more complex given the welter of inter-se revenue and capital account transactions that it has with its holding company and its four fellow subsidiaries. It is some sort of a jungle out there.

Too big to fail

But the good news that really has going in favor of Kingfisher is that it is too big to be allowed to fail - it had borrowings alone of close to Rs 80 bn, and almost 7,500 employees for starters (inspite of all the hi-tech, the airline industry is very labor intensive.) Not included here is the value addition that the company generates each year. As a matter of fact, the entire airline sector has such a large collective stake together, that it has both the Ministry of Civil Aviation and all its creditors in a bear hug. This is the trump card that the industry will use to extricate itself, and at its own pleasure. So where is Kingfisher Airlines falling short?

In FY10 the company made a loss of Rs 20 bn, after providing for interest, depreciation, and other extraordinary charges. Interest cost debited to P&L account came to Rs 11 bn, depreciation of Rs 1.6 bn, extraordinary costs due to premature termination of contracts of Rs 3.6 bn, and forex fluctuation loss of Rs 500 m. But even after excluding these costs it left the company short by Rs 3.4 bn. (This working excludes accounting changes inimical of the guidelines set out by ICAI, and unpaid bills for the year at year end.) Clearly the biggest factor hamstringing its working is the interest burden. And the reason for this is that it is severely undercapitalized. Against a paid up capital of Rs 3.6 bn, (which includes preference capital of Rs 970 m) it had borrowings totaling Rs 79 bn. (The ultimate holding company of Kingfisher is United Breweries Holdings Ltd.) This is clearly unacceptable, given that airlines are high capex intensive, and operate on razor thin margins, given the high operating costs. Owning an airline is however considered supra dig! (The only major industry in America that went belly up after the 9/11 attack by the Al Qaeda, and in short order at that, was the aviation sector.) Ideally, airline companies should have a 1:1 debt equity ratio, to give them the space to operate in. But this never happens in reality, as no entrepreneur will stick his neck out and put down the humungous sums of dosh up front, preferring to transfer the risk on to the financiers. The problem that Kingfisher has in revving up its capital base is that the promoters, who hold 66% of the voting capital, are cash strapped, and do not have the bucks to bring in the additional equity. Also, any public issue of capital at this stage may not have any takers, given the dire operating stats.

Asset strapped

(As a matter of fact the company is so asset strapped that even its secured loans of Rs 48 bn is apparently secured only to the extent of Rs 36 bn, and the security includes such intangibles as the Kingfisher brand. The word 'secured' seems to have taken on a new meaning it appears. The unsecured loans of Rs 31 bn includes loans personally guaranteed by a director, and loans to the extent of Rs 12.4 bn are subject to a conversion option into equity shares at par. No deadline appears to have been given for this conversion though, except for the default clause.)

That leaves them with only one option and that is to raise capital from the many tax havens that dot the global geography. But the current FDI (foreign direct investment) policy of the Indian government does not permit foreign airlines to invest in domestic carriers. However, a 49% investment is allowed to foreign institutional investors, and the Government is considering extending this cap to foreign airlines as well, based on representations made to the government by the industry. (Each national airline till recent times was considered a nation's pride and strictly off limits to foreign predators.)

The complexion of the board

One also wonders after looking at the complexion of the board of directors' of the company, as to the seriousness of purpose of the management. The list includes a falooda mix of personalities including Vijay Amritraj, former finance secretary Piyush Mankad, adman Dewan Arun Nanda, a retired executive A K Ganguly, and former SEBI top gun G N Bajpai. Hopefully these distinguished gentlemen are able to proffer some eminent advice if nothing else. If Bajpai was the SEBI chairman he may have held very differing views on the functioning of this industry.

PLEASE NOTE THAT I AM NOT A SHAREHOLDER OF THIS COMPANY

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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