Kenya Airways has ordered 10 E-190 jets from Embraer, making it among the Brazilian aircraft manufacturer’s top 10 customers in the world and the biggest in Africa.
While the deal will help Embraer expand deeper into Africa, it brings with it major opportunities and challenges for KQ, which has similar ambitions.
This deal is expected to transform the capital structure of KQ from that of a middling African carrier, to a more complex one of a carrier that is now hungry for cash to finance its expansion. Already, the carrier is asking existing shareholders — with the government of Kenya and KLM the biggest of them — to increase common equity by $247 million. The Treasury has already budgeted nearly $60 million for this.
While such a rights issue may look ambitious going by recent efforts by KCB, this cash alone will not be sufficient to pay for KQ’s expansion over the next five years. For one, as Ghislain Boüan, Embraer press officer for Europe, the Middle East and Africa, told The EastAfrican, a new Embraer E190 is selling at a pre-discount price of $42.8 million. So in KQ’s case, which is buying its E190s in cash, the 10 planes will cost $428 million.
It is clear why KQ has taken the cash route, going by the debt covenants it maintains with the banks and other lenders. At its current level of capitalisation, the airline has a gearing ratio of 79 per cent, meaning that every shilling of shareholders net equity supports 7.9 shillings in debt. Simply put, creditors have little headroom with KQ — if the airline started racking up huge losses without government support, it would face difficulties staying afloat and repaying its debts.
However, if KQ were to dip into its treasure chest of profits reserve currently valued at $200 million — which could be paid out as bonus shares — and proceed to raise the $250 million it plans to raise through a rights issue, it will significantly expand its capacity to borrow aggressively to pay for expansion. Then there would be the question of generating robust free cashflows to repay the loans and still pay out a regular dividend.
Expansion means KQ has to increase its fleet — and the airline indeed plans to double its fleet of 31 aircraft in five years’ time to protect its lucrative African market.
Africa accounts for nearly half of KQ’s $1.1 billion turnover, a figure that is likely to increase with more African routes being launched during the current financial year ending March 2012.
With KQ last week finalising the contract for acquisition of the 10 Embraer jets — each with a capacity of 96 passengers — by 2013, the airline aims to reduce the average age of its fleet from 8.3 years to around 6.2 years. This will help reduce operational costs.
The Embraer 190 has a range of about 4,500km, which means the farthest KQ can fly the plane is between Nairobi and Equitorial Guniea to the west in a non-stop flight and between Nairobi and South Africa to the south.
KQ has the option of buying an additional 16 planes from the Brazilian manufacturer.
Short and medium haul routes
Acquiring the narrow-bodied Embraer means KQ is eyeing short and medium haul routes as well as increased frequencies on the African continent, where there is great potential for growth.
“Foreign interest in Africa’s resources and manufacturing potential is prompting new developments in many industries. This in turn should promote new airline links as regional economies improve,” say Embraer in their outlook on the aviation market for 2011 to 2030.
But the fleet expansion means KQ has to raise cash to expand its fleet, recruit pilots and strengthen top management to drive the 10 year expansion plan.
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