Business

Saturday September 12, 2009

Fuelled for growth


Azmil believes MAS made the right decision not to unwind its fuel hedges.

FUEL is the biggest cost item for any airline. Malaysia Airlines (MAS) recognised RM3.8bil on its balance sheet as hedging losses as at Jan 1, 2009 and at the same time adopted the FRS 139 accounting standard.

Tengku Datuk Azmil Zahruddin ... ‘This year is a tough year but we expect a better second half in 2010.’

However, this is unrealised as derivative losses caused by writing down the value of contracts to market value – mark-to-market (MTM) – effectively paper losses which will only be realised over the next three years.

The airline’s hedging portfolio and MTM position comprise fuel hedging contracts which have maturity dates up until Dec 2011.

For the first quarter, MAS reported net losses of RM695mil which included RM557mil in derivative losses due to volatile oil prices. In the second quarter, the airline made a net profit of RM876mil which was largely aided by a RM1.34bil derivative gains on fuel hedging.

The airline made an operating loss of RM420mil due to lower operating revenue led by a decline in global travel and cargo movements. Whether it would continue to make derivative gains depends on which path oil prices will take. This week, crude oil prices hovered around the US$70 a barrel level.

For now, newly appointed managing director and CEO Tengku Datuk Azmil Zahruddin remains optimistic that MAS has made the right decision not to unwind its hedges.

He spent over an hour with StarBizWeek’s B.K. Sidhu, Anita Gabriel and P. Gunasegaram recently to talk about his strategy for the airline, the global challenges, what he learnt from his predecessor as well as whether he is ready to work together with rival airline AirAsia’s boss Datuk Seri Tony Fernandes.

Below are excerpts from the interview:

StarBizWeek: Did MAS hedge far more than others?

Azmil: We follow competitive hedging and benchmark ourselves against other airlines. We do not stray too far. We will not be smarter than many of those airlines and there is no reason to believe we can do a better job. We do hedging as a means to protect against high prices and to remove future fuel price uncertainty. Our hedging is also at the median level. It is normal to hedge about 50% of your fuel requirements and for two to three years.

Our losses are comparable with other airlines. Had we not hedged, we would have lost RM3.95bil in 2008. Other airlines also lost in excess of US$1bil. What matters at the end of the day is how much you end up paying in cash. It is not going to be very different (from what others would pay). We were given extension for some of our hedges and they stretch to 2011.

Is it necessary to do competitive hedging? Can’t you use your own judgement and write the hedges to benefit in a downside and cap the upside?

You can ... but it can be very expensive.

If MAS had adopted FRS 139 for financial year ended Dec 31, 2008, it would have had to provide for MTM losses of RM3.8bil, which would be reflected in the company’s profit and loss rather than balance sheet right?

Based on the FRS 139 transition rule, the unrealised MTM gain or loss at the point of adoption would impact balance sheet (not profit and loss). As for the timing of adoption, most companies prefer to adopt any new standard at the beginning of the year to avoid restating the results of prior quarter(s) of the year. The decision to adopt FRS139 was only made in 2009.

It was logical to apply it from 2009 as the first quarter results had not been announced. It did not make sense for us to consider adoption from 2008 in these circumstances.

Is MAS tied to a high cost of hedging?

We are paying more for fuel but still less than last year. Had we not hedged, it would be lower. It is easy to talk on hindsight. We have hedged at a price that is higher than spot prices for crude oil ... at slightly less than US$100/barrel of jet fuel. For the first quarter, crude oil prices were lower, but it went up in the second quarter and higher in the third. It is difficult to say whether it will come down. Crude oil at US$140-US$150 a barrel was ridiculous. In this very deep recession, crude is at US$70 a barrel and the real risk is that when the economy recovers, fuel prices will shoot up again ... (so it will help if we are hedged).

How much of fuel does MAS consume in a year?

About 15-16 million barrels. This year, 47% of our fuel requirement was hedged. Next year it is 60% and in 2011, about 40% (all at around US$100/barrel).

AirAsia unwound its hedges at US$80 a barrel and has not got into new hedges as yet. Isn’t it a contrasting strategy versus other airlines?

We will not comment on that. They are the only airline doing it and hedging is designed for long term, normally for two years.

The losses from hedging will be a drain on MAS’ cashflow over the next two years and will impact profits as it will have to be recognised as charges, correct?

We will pay more if we did not hedge. But the problem is not that. It is about traffic and revenues which have collapsed.

But you are paying US$100 a barrel when market prices are much lower than that?

It does look that way. Most of our hedges have a floor. For example, if oil goes below US$80 a barrel, we pay for the hedge at spot price and the price that we pay is below US$100.

What was the cash drain last year?

Our operating cash flow is negative. That is our focus today and we are doing everything to get more passengers into our planes. We are working to improve seat factor, improve yields as the real problem is shortfall in revenue. This year’s fuel cost is less than last year but revenues are coming down faster than the drop in operating expenditure.

When do you expect to see better cash flow?

This year is a tough year but we expect a better second half in 2010.

MAS did not unwind the hedges to keep cash in the company?

Partly. We also cannot run the company just because fuel prices go higher or lower.

If MAS were to unwind its hedges, will it cost a lot more or as much as 2009?

If we decided to unwind we would be kicking ourselves. MTM can be very volatile. You cannot make a decision at one point in time. The competition is doing similar things that we are doing.

Would MAS raise fares in the second half of next year?

When the load factor is up, there is less reason to drop fares. All airlines need to increase fares collectively and when planes are not filled that is why fares are dropped.

How is the load factor over the last eight months?

July and August load factor was better than last year. Despite the fasting month, we have better load factor. In August it was 80%. But yields are down. We have better ability to improve yields if the load factor is higher. We are relatively optimistic and doing quite a lot in managing the situation that we are in.

Will you need to tweak the BTP 2 (business turnaround plan)?

BTP 1 was about survival and BTP 2 about turning MAS into a five-star value carrier. We would need to tweak BTP 2 but more importantly it is about reinforcing. That is the key message that I have been giving out.

What is the takeaway from your predecessor Datuk Seri Idris Jala?

It is execution. It is phenomenal how Jala did it. He is the best person for that. He made sure everyone understood what they were doing. Many CEOs delegate because they are busy. But he was there and everyone had no choice but to execute. He was watching everyday and it takes quite a lot to really do that. Execution is key and that is more important than strategy.

What was the most challenging task Jala had to do while at the helm of MAS?

The toughest challenge was when we had to do the domestic rationalisation and at the same time we had to do the mutual separation scheme where a large chunk of our staff was leaving. That was not something anyone wanted to do at that time.

How is the relationship between you and Tony Fernandes?

To be honest, there is nothing personal between Fernandes and Jala. We are competing in the same space but we do not get personal. I do not have any problems with Fernandes and Jala does not have any problems with him too. There are some things they share in common – they both like music and the same type of beer.

Is Firefly profitable?

We cannot disclose that but it is the fastest growing airline in percentage terms. It is a unit of MAS and predominantly services routes that MAS does not cover. We have had good feedback and it is certainly doing very well. Even in this difficult environment, growth is very significant.

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