SAA Quarterly Report

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Finance Standing Committee

29 November 2017
Chairperson: Mr Y Carrim (ANC)
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Meeting Summary

The South African Airways (SAA) presented its: quarterly report; progress in implementation of the 5-Year Corporate Plan; specific financial issues relating to government guarantees and repayment obligations; as well as conditions for recapitalisation. National Treasury also highlighted progress in coming up with the new state-owned enterprises (SOE) engagement framework.

The newly appointed SAA board and management expressed its determination to make the airline a commercial success, and said it had seen heartening enthusiasm from staff to help return it to profitability. The numerous reasons for SAA’s extreme reliance on debt were outlined as follows: 

  • Weak Capital Structure: SAA is over geared and finance costs are causing additional strain on profitability.
  • Overreliance on leasing Aircrafts: Only 9 of the 64 Aircrafts are owned by SAA. SAA’s lack of profitability weakens its negotiating power over suppliers.
  • Increased competition : Domestic and international competition is driving margins down
  • Poor commercial capability : All domestic routes and most international routes that SAA services are not profitable as a result the company is not able to generate cash hence the over reliance on debt to finance operations.
  • Ageing fleet and poor fleet profile: Is driving cost to operate and eroding efficiencies respectively.
  • High cost structure: SAA has very high operating cost structure.  

On financial and operational performance, revenue had improved but there were still shortfalls with losses for the current year expected to reach R4 billion. The reason the company's losses would exceed a forecast of R2.8 billion was largely related to the retirement of five aircraft which has forced it to cancel flights. Its maintenance bill for the second quarter exceeded its budget by R300 million. However, SAA did not plan to immediately revise its five-year turnaround strategy under the new CEO's leadership, but would stress-test it. The second quarter had seen improvements in revenue, with a year-to-date revenue shortfall of R879 million; marked improvements on average fares; and operating costs coming in line with budget. Maintenance costs exceeded budget by R300 million and finance costs reduced by R141 million. Furthermore, interventions to improve financial performance would entail improving liquidity; loan repayment; revenue stimulation; route optimisation; and cost optimisation.

SAA had made inroads on the implementation of the 5-Year Corporate Plan as it had made frequency changes on high loss making routes; grown the ancillary revenue; implemented traction revenue improvement initiatives; optimised freighter operations, and had renegotiated catering contracts at out-stations and improved product specifications. However, immediate interventions were geared towards: unlocking cash opportunities through tighter cost management; revenue optimisation; redefining the operating model; filling critical vacancies to strengthen capabilities and delivery; and focusing on the employee engagement framework.

National Treasury said it was in the process of finalising a new state-owned enterprises (SOE) engagement framework. The framework — which had to be finalised by March 2018 — would be presented to Cabinet for approval. The new framework would introduce a limit on the size of guarantees to SOEs; would prohibit the issuance of guarantees for operational expenditure; would not allow the issue of guarantees for social projects; would require that guarantees be targeted towards capital projects; and would ensure that the rollover of guaranteed debt on maturity was not automatic but would require a new application. Most importantly, there will be clear, measurable and practical conditions and performance targets that will be attached to guarantees. Consideration would be given to imposing a guarantee fee as a penalty in the event of noncompliance with these conditions. The size of the penalty would be linked to the extent of the noncompliance. The aim of the new framework would be to discourage SOEs from making applications for guarantees, because this happened too frequently. Currently, Treasury only had a "soft" limit for debt and guarantees combined, and it would not want to continue with the "musical chairs" practice of replacing debt of SOEs with government debt — as had been the case with the R10 billion recapitalisation for SAA. Treasury would not want to do that going forward. Ways and means of reducing both the guarantees as well as reducing the debt and ultimately getting the economy to grow at much higher levels than it is currently had to be found.

Members pointed out that SAA seemed to be finding its feet. It therefore had to be fully supported. They suggested a review of open sky policy. It could be time for SAA to engage the Minister of Transport about reviewing the open skies policy in South Africa. South African skies are too open. They implored stakeholders such as government and workers’ unions to assist the airline in its turnaround efforts. The Committee was rightly hopeful that the new Board and CEO would lead a successful turnaround strategy.

The Chairperson was very encouraged. However, the Committee would judge the airliner by what happens in practise. The spirit of the meeting, including executives' readiness to answer questions, marked a welcome shift. What had been done within a month was quite impressive.

Meeting report

Opening remarks

The Chairperson welcomed everyone and acknowledged receipt of responses to Members’ questions from a prior engagement with the South African Airways (SAA). SAA was expected to present its: quarterly report; progress in implementation of the 5-Year Corporate Plan; specific financial issues relating to government guarantees and repayment obligations; as well as conditions for recapitalisation.

Mr Johannes Magwaza, Chairperson, SAA Board, appreciated the Committee’s invitation and noted that when the SAA delegation comes to an open session in Parliament where the affairs of the (airline) are discussed, it finds it hard to deal with quite sensitive information. SAA had to do its laundry – dirty or clean – in public. The SAA delegation would try to give as much information as it could get away with in terms of (competitive considerations). He added that where necessary, any such sensitive information could be shared with the Committee in camera. Unlike other state-owned enterprises (SOEs) in South Africa, which operate in what could be described as a monopoly situation; SAA operates in a competitive free market.

SAA presentation

Mr Vuyani Jarana, CEO, SAA, took the Committee through a presentation on SAA’s performance since the new board and management assumed office. He emphasised that he was determined to make the airline a commercial success, and said he had seen heartening enthusiasm from staff to help return it to profitability. SAA started making operating losses in 2012. Notably, the company would have to find R4 billion to pay back foreign and local lenders by the end of March in 2018. He emphasised that the lack of stability undermined strategy execution. On the balance sheet profile, even with the recent bailout from Treasury of R10 billion, SAA will remain undercapitalised with a negative equity position of over R9 billion. On the allocation of the recent R10 billion capital injection, R7 billion will be used to repay lenders whilst R3 billion had been used to address short term working capital challenges.

The numerous reasons for SAA’s extreme reliance on debt were outlined as follows: 

  • Weak Capital Structure: SAA is over geared and finance costs are causing additional strain on profitability.
  • Overreliance on leasing Aircrafts: Only 9 of the 64 Aircrafts are owned by SAA. SAA’s lack of profitability weakens its negotiating power over suppliers.
  • Increased competition : Domestic and international competition is driving margins down
  • Poor commercial capability : All domestic routes and most international routes that SAA services are not profitable as a result the company is not able to generate cash hence the over reliance on debt to finance operations.
  • Ageing fleet and poor fleet profile: Is driving cost to operate and eroding efficiencies respectively.
  • High cost structure: SAA has very high operating cost structure.  

Mr Jarana said SAA was not bereft of strategies. What was of importance was the effective execution of the strategies. Therefore, the main task was "bringing back liquidity" to the company that currently had outstanding debt of R13.8 billion.

Ms Phumeza Nhantsi, CFO, SAA, highlighted SAA’s September 2017 year-to-date performance. Revenue had improved but there were still shortfalls with losses for the current year expected to reach R4 billion. The reason the company's losses would exceed a forecast of R2.8 billion was largely related to the retirement of five aircraft which has forced it to cancel flights. Its maintenance bill for the second quarter exceeded its budget by R300 million. However, SAA did not plan to immediately revise its five-year turnaround strategy under the new CEO's leadership, but would stress-test it.

On financial performance, the main highlights were: improved revenue in the second quarter, with a year-to-date revenue shortfall of R879 million; marked improvements on average fares; and operating costs coming in line with budget. Maintenance costs exceeded budget by R300 million and finance costs reduced by R141 million. Furthermore, interventions to improve financial performance would entail improving liquidity; loan repayment; revenue stimulation; route optimisation; and cost optimisation.

SAA had made inroads in the implementation of the 5-Year Corporate Plan as it had made frequency changes on high loss making routes; grown the ancillary revenue; implemented traction revenue improvement initiatives; optimised freighter operations, and had renegotiated catering contracts at out-stations and improved product specifications. However, immediate interventions were geared towards: unlocking cash opportunities through tighter cost management; revenue optimisation; redefining the operating model; filling critical vacancies to strengthen capabilities and delivery; and focusing on the employee engagement framework.

Ms Nhantsi outlined the conditions for recapitalisation as follows: SAA had to provide an implementation plan for its five year turnaround, approved by the Board and submitted to the National Treasury by 30 December 2017; it had to achieve at least 90% of the outputs as outlined in the Board Approved implementation plan by 31 March 2020; the Board had to provide an action plan to address findings from all independent forensic investigations by 30 December 2017 and also had to implement the action plan to address findings from all independent forensic investigations by 31 March 2018. Moreover, non-core assets for potential disposal had to be identified and the submission of recommendations thereon to the Minister of Finance for consideration had to be made by 30 December 2017. The airline was also expected to appoint a Chief Commercial and Chief Strategy Officer by the 31st January 2018, and provide a comprehensive decision making framework for commencement and cessation of routes by the 31st January 2018.

More significantly, SAA was recently granted a reprieve by local lenders that agreed to extend maturing loans until March 2019. The annual general meeting was scheduled for 19 January 2018.

Discussion

Ms T Tobias (ANC) appreciated the presentation and commented that SAA seemed to be finding its feet. It therefore had to be fully supported. In her view, other airlines have outsmarted SAA. It was all about strategy. Maybe the Competition Commission should be brought in on the issue of price setting. The Committee just wanted to look at the bottom line of SAA - at its balance sheet.

Mr A Lees (DA) commented that SAA was capable under the right circumstances and these were now emerging. What remained was to allow the SAA team to work as a commercial enterprise without interference. He suggested that in future, the Committee ought to liaise with the Standing Committee on Appropriations for joint meetings with SAA if possible. The SAA Board and management had a huge role ahead of them and coming to Parliament for both meetings, with overlapping discussions, was not the best arrangement.

Mr F Shivambu (EFF) said that SAA should be closely monitored and that the Committee should receive progress reports periodically and more frequently. SAA should also explore other revenue sources to increase its revenue flow and ensure viability. He told the SAA Board chair that he "buys into" the view that perhaps some important SAA statistics should not be made public as it operates in a competitive space and this could undermine strategy implementation.

Ms P Kekana (ANC) suggested a review of the open sky policy. How will the posture of SAA be going forward? It could be time for SAA to talk to the Minister of Transport about reviewing the open skies policy in South Africa. South African skies are too open. Members were not saying a plane should not come straight from Dubai to Cape Town, but sometimes it brings unintended consequences to the country’s own national carrier. Without wanting to disallow provinces to also make their own decisions, there must be high level consideration of (open skies). SAA is a national carrier and there was no way it cannot be supported. She also wanted to know why SAA does not own an airport like many other national carriers around the world. She would like the airline to talk to the Minister of Transport about this as well. Although ACSA (Airports Company South Africa) was doing very well, SAA was competing with airlines which also own airports. SAA can also be in a position to own airports only if it shows that it has capacity. She added that SAA cabin crew had informed her of a great deal of wastage, especially in business class catering. She also agreed that there might be instances when it would be best to talk to SAA in camera when engaging on some of the things Members wanted to see happening in SAA.

Ms D Mahlangu (ANC) said the new team was expected to bring about real change within SAA, and the positive developments were encouraging. There was an expectation that previous imprudent decisions would be corrected. South Africans and the world at large must take pride in flying SAA.

The Chairperson congratulated the new SAA board membership and management for their appointment- they were in an unenviable position given the current state of SAA. He implored stakeholders such as government and workers’ unions to assist the airline in its turnaround efforts. The Committee was rightly hopeful that the new Board and CEO would lead a successful turnaround strategy. However, the Committee still felt there was a need for additional aviation expertise within the Board. He asked for Treasury’s input.

National Treasury input

Mr Antony Julies, Deputy Director-General: Asset and Liability Management, National Treasury, said Treasury was in the process of finalising a new SOE engagement framework. The framework — which had to be finalised by March 2018 — would be presented to Cabinet for approval. The new framework would introduce a limit on the size of guarantees to SOEs; would prohibit the issuance of guarantees for operational expenditure; would not allow the issue of guarantees for social projects; would require that guarantees be targeted towards capital projects; and would ensure that the rollover of guaranteed debt on maturity was not automatic but would require a new application. Most importantly, there will be clear, measurable and practical conditions and performance targets that will be attached to guarantees. Consideration would be given to imposing a guarantee fee as a penalty in the event of noncompliance with these conditions. The size of the penalty would be linked to the extent of the noncompliance. The aim of the new framework would be to discourage SOEs from making applications for guarantees, because this happened too frequently. Currently, Treasury only had a "soft" limit for debt and guarantees combined, and it would not want to continue with the "musical chairs" practice of replacing debt of SOEs with government debt — as had been the case with the R10 billion recapitalisation for SAA. Treasury would not want to do that going forward. Ways and means of reducing both the guarantees as well as reducing the debt and ultimately getting the economy to grow at much higher levels than it is currently had to be found.

Discussion

The Chairperson agreed with Members that the SAA submission was cogent. However, transformation targets seemed to be missing. They had to be embedded more into the airline’s operating framework and strategy going forward. Its procurement strategy should seek to empower the previously disadvantaged strata. He urged the new Board not to bow to undue influence and pressures from any front. He also wanted to know why the Black First Land First outfit was not in attendance as per usual during SAA appearances.   

Mr Shivambu added that the transformation agenda should be prominent in SAA’s turnaround strategy. He asked for a comprehensive procurement report which would be reviewed and the Committee could provide guidance if necessary. In an effort to support SAA and its subsidiaries, he suggested that the Committee write to the Speaker requesting her to consider reviewing parliamentarians’ travel policy so that Members could also use Mango when travelling on parliamentary business. He advised the new team to stay away from criminal elements who had destroyed a number of SOEs.

Mr Magwaza was humbled by Members’ tone. The SAA executive would not abuse the trust afforded to it by the Committee. He replied that aviation expertise was present but the need for even more as identified by Members was noted. The SAA executive believed in a corporate culture of responsibility and the new board and management was on a drive to inculcate it. They were going to make sure that they come up with a credible strategy to take the airline out of its current quagmire. Lastly, corruption would not be tolerated. There would be dire consequences for the transgressions unearthed through the recently concluded forensic investigations.

Mr Jarana appreciated Members’ inputs. They gave guidance in mapping a robust strategy for the airline going forward. The commitment towards transformation and progressive change across the board was encouraging. A systematic rather than ad hoc transformation framework was work in progress. People’s ideas had to be taken into account. On the argument about whether SAA should lease or buy aircraft, the SAA business was run on a commercial basis and therefore with its currently weak balance sheet, leasing made more commercial sense. Leasing rather than purchasing aircraft at this stage was purely a business decision informed by prevailing conditions rather than an ideological position. Also, the SAA executive was working on an optimal capital structure that would be approved and made public. All stakeholder inputs would be taken into account in developing a holistic strategy.

The Chairperson said Members were very encouraged. However, the Committee would judge SAA by what happens in practise. He wished the new team well mindful of the crucial role they had to play. The spirit of the meeting, including executives' readiness to answer questions, marked a welcome shift. What had been done within a month was quite impressive. In conclusion, he asked Members to submit proposals on what the programme should be for the first quarter next year. 

The meeting was adjourned.

 

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