|Shares Out. (in M):||181||P/E||4.7x||5.0x|
|Market Cap (in $M):||8,600||P/FCF||5.3x||6.6x|
|Net Debt (in $M):||960||EBIT||1,050||960|
|TEV (in $M):||9,560||TEV/EBIT||4.0x||3.9x|
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We will try to keep this short and sweet – the idea we are proposing is long Japan Airlines.
They are one of the big two carriers in Japan (along with All Nippon Airlines) – they went through a fairly spectacular bankruptcy in recent years, and
re-emerged onto the market in Q312 (Bloomberg ticker 9201 JP). The reasons for the bankruptcy are manifold, but the quick explanation would be too
much capacity, too much capex, not enough profit, and too much debt –disaster eventually unfolded. From 1998-2009, the operating margin average
was about 1% and it never went above 4%- at the net level they lost about 192bn yen over this time period. We think the key reason for such a
poor level of profitability was overcapacity – a report claims that over the 90’s, domestic capacity rose, on average, about 6% per annum – to keep
the load factor high, prices were reduced by around 3% per year. The high level of capacity of course implies a lot of investment, and indeed that
was the case with Japan Airlines – a tremendous amount of investment was made in unprofitable capacity additions, hence the free cash flow
performance was even worse than the profitability:
|Cash From Operations||92,457||81,727||87,326||129,098||24,589||155,413||76,345||145,275||100,984||127,748||157,331||31,755|
|Free Cash Flow (JPYm)||-49,835||-48,012||6,175||48,827||-78,250||-40,162||-75,240||23,315||-45,988||-25,503||-17,500||-136,101|
So negative cumulative free cash flow of 440bn yen from 1998 to 2009 (and this is not even accounting for most of the 90’s, when the capital
discipline was even worse). The yields did start to pick up a little towards the middle of the 00’s, but by then it was too late – much of the damage
had been done and the lack of capital discipline (capex was still well above depreciation as the yields picked up) caused the balance sheet to
collapse under its own weight:
|Current Portion LT Debt||136,530||181,667||142,293||150,796||198,188||144,718||127,974||145,323||182,530||158,335||180,426|
|Cash & Equivalents||244,022||237,651||121,489||133,880||147,766||144,431||253,239||179,884||212,167||363,772||173,087|
The inevitable happened and the company filed for bankruptcy. Over the course of the bankruptcy, a few important changes occurred to the business:
Fleet & Network
Total number of aircraft (excluding cargo) reduced from 225 in March 2009 to 169 as of March 2012, while the number of models in the fleet fell from
seven to five; average age fell from 11.7 years to 9 years, so it is a more efficient fleet with lower maintenance and fuel costs.
The number of domestic routes they service directly was reduced from 153 to 112, while the number of international routes fell from 67 to 47, with the
focus being on high-yielding routes where they have strong market shares.
Wages, Salaries, Headcount
Headcount was reduced from 48,000 to 30,875, salary cuts of 20% – result has been that the wage cost as a percentage of revenue has fallen from
a high of 26.4% in 2004 (and 19.1% in 2007 for a somewhat more recent example) to 17.7% in 2012.
Debt, Pension Obligations
The titanic debt load was reorganized, with a partial debt waiver (unsecured debt took an 87.5% haircut) resulting in a 583.7bn gain, but the key point
being that net debt (our definition) fell from 723.3bn by y/e 2009 to 88.9bn as they exited 2012.
Official line is that they’re now focused on “divisional profitability”, with each of about six mini-divisions responsible for their P&L and the results tracked
on a monthly basis against targets for that month and future months. There have also been cost cutting measures mentioned (looking at airport and
facility costs, better response to systematic event risks, more asset sales). Obviously talk is cheap, but we’d not that over the course of 2012 they were
able to report operating margins of 6.7%, 25.8%, 17.9% and 14.6%, respectively.
Together with the measures above, some financial targets were announced to keep the company on the straight and narrow and ensure focus is
maintained – these include:
Japan Airlines Now
Company now derives about 40% of revenues from domestic passengers, 32% from international and 28% from incidentals.
The domestic market is dominated by Japan Airlines and ANA (85% combined market share with JA controlling 37%) – the two key airports are Haneda
(67% of domestic traffic) and Itami – they hold 41% of the domestic departure and landing slots at Handa, 49% at Itami. Not sure how much of a moat
that is for the business really as the load factors are pretty low (63%) and there is increasing talk of LCC attacking them – they actually own part of a
LCC JV called JetStar to help to address the threat.
From the work we have done, we believe the domestic market continues to be pretty lucrative for them, and we see some increasing price competition
from the LCCs (should be partially offset by a better premium offering) and limited volume growth (company have said they do not see themselves
adding much capacity). We think that the “yield” (measured by revenues divided by ASK) continues to be pretty high (certainly above the 11.5 unit cost)
and forecast some compression:
|Revenue Passengers Carried||33,342,308||28,965,514|
|Revenue Per Customer|
|Average Distance Travelled|
|Revenue Per Kilometre Traveled||20.9||21.6||21.1||20.8||20.3||19.3||18.3|
|Revenue Per Kilometre Available||12.9||13.5||13.3||13.4||12.9||12.2||11.5|
|Change in Pricing||3.4%||-2.6%||-1.0%||-2.5%||-5.0%||-5.0%|
|Change in Load Factor||0.8%||0.4%||1.0%||-0.5%||-0.5%||-0.5%|
Probably the key risk we see to that line of business is that the politicians/public have been shown to be a bit unhappy about the route closures –
think the popular view seems to be that the state has bailed them out and they have responded to that by laying off loads of people and reducing
the quality of the service. Company have said that domestic routes only get reopened if they are profitable and that is that – we’ll see how it pans
The LCC are also obviously a threat to the business, but the company think that a lack of availability to departure and landing slot availability
will impair the ability to really compete hard in the short-term.
The international business is operated out of Narita (largest international airport) and Haneda (second-largest) – they have the highest number
of departure and landing slots at both. Biggest routes by far are transpacific (to the US and Canada – about 35% of ASK at 76.8% load factor)
and SE Asia (about 30% of ASK at 63.7% load factor). It is a much more “efficient” business in terms of load factors (70.4% in 2012 rising to 76.2% i
n 2013) but on the work we have done, we think less lucrative:
|Revenue Passengers Carried||8,284,144||6,844,772|
|Revenue Per Customer|
|Average Distance Travelled|
|Revenue Per Kilometre Traveled||11.0||12.7||11.9||11.5||11.7||12.0||12.2|
|Revenue Per Kilometre Available||8.1||9.0||9.0||8.9||9.0||9.1||9.2|
|Change in Pricing||15.5%||-6.7%||-3.0%||2.0%||2.0%||2.0%|
|Change in Load Factor||-3.1%||5.7%||1.0%||-0.5%||-0.5%||-0.5%|
The strategy is to add more of the Boeing 787s to this part of the business over time (20% more fuel efficient with fuel being 19.3% of sales in
2012 for the group) which should help. Key risk we really see to this business line is that it is fiercely competitive and new slots are being opened
at the two main airports in the next 2-3 years that will add double digit percentage capacity. Company have said that they expect to get their fair
share of the slots but we wonder what it does to pricing. We see it modestly up (again the increased premium offering offsetting some price
competition) but it is a risk.
In terms of the cost structure – they are at 11.5 unit cost now and they are targeting 11 by 2017. In terms of how exactly they get there – capacity
should be growing at something like 3.5% CAGR out to 2017 (that is all international as the 787s they have on order are deployed) – costs probably
do not need to grow that much annualized – wages we have up 6.1% this year and another 5% in 2014 (staff had a rough time and company guiding
for bigger bonuses) before stabilizing at +2.5%. Fuel we think will be up something like 12% in 14 after a rise of nearly 8% this year (we have the
workings behind this if anybody has a burning desire to pick out holes in the idea), then everything else (maintenance, rent, incidentals and so on) we
think can grow much less.
It’s a little bit of a case of it being a leap of faith going from the excel model to actually seeing it in the P&L, so the jury is out, but all we can really do
is observe they have been quite disciplined so far.
The target when they listed again was to deliver operating profit of 150bn on revenues of 1,220bn – that target has since been upgraded a couple of
times – to 165bn at the Q213 stage, then 186bn ant the Q3 stage, Things seem to be working out pretty well so far – we have them on track to do
about 185bn of EBIT, which should translate to nearly 170bn of net income (tax loss carry forwards mean they will pay little tax for the next 5-7 years):
The better cost structure and better capital discipline should mean that the profitability is translating into quite a bit of cash flow as well:
We actually have EBIT declining, which is obviously a worry (and probably explains the valuation a bit) but we see 100bn+ as a mid-term
FCF that is certainly achievable. That is against a market capitalization of just shy of 800bn. Not bad.
In terms of what it could be worth – on peer multiples it’s one of the most profitable, high return-generating listed airlines and also one of the cheapest:
Asian peers trade at a P/E of double what these guys do for generally lower returns and margins, which gives a sense of the type of upside that is
With the usual health warnings applied to even trying to do a DCF on a company in such an unstable industry – we have done it anyway – resulting
upside is over 50%:
In terms of what closes the gap – they have upgraded their guidance a couple of times since the relisting which should hopefully help to build a bit of
confidence in the management team.
Would also highlight that they have targeted an equity ratio of 50% in the medium term – they are accumulating equity fairly prodigiously – it was
44.8% as at the Q313 stage against 35.7% at 2012 y/e – at this rate they are going to hit their target within the next 12-18 months – we wonder
whether special dividends could be on the cards. They upgraded the payout ratio from 15% at the relisting to 20% (DPS will be 180 against share
price 4400) as they said feedback from investors was that they wanted more returns. We wonder if perhaps the company have found religion on
capital allocation and that could be a catalyst.
For us, on our adjusted measures, the ROIC in 2012 was about 21%; it should be in the very high teens again this year; the market valuation is
implying single digits into perpetuity. It is a horrible industry so maybe that is right and they start to try to add loads of capacity again and price
competition really hurts them badly – gut given what they are doing now and what the market is implying – we think it is a risk that we are being
quite well-compensated to assume.
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