This article first appeared in The Edge Malaysia Weekly on March 8, 2021 - March 14, 2021

SOVEREIGN wealth fund Khazanah Nasional Bhd’s drastic drop of more than RM3 billion in profit before tax in 2020 calls into question how far the fund is willing to go to hold on to Malaysia Aviation Group Bhd (MAG) and its subsidiary Malaysia Airlines Bhd.

Last year, Khazanah posted a pre-tax profit of RM2.9 billion, from RM7.36 billion in 2019. The performance of its Strategic Fund — one of two funds it invests in, the other being the Commercial Fund — was only marginally higher by 0.3%, calculated based on net profit over net tangible assets, excluding that of MAG’s. The performance of the Strategic Fund was badly dented by impairments amounting to RM6 billion, of which more than half was due to MAG.

According to Khazanah president and group CEO Datuk Shahril Ridza Ridzuan, the carrying value of MAG in Khazanah’s book is nil at present — in other words, the airline is essentially worth nothing in Khazanah’s balance sheet.

Even so, the custodian of Malaysia’s sovereign wealth fund maintains that national airlines are still considered strategic assets and part of the connectivity infrastructure that is so essential to the development of a country’s economy.

Furthermore, he insists that the costs of allowing a national carrier to fail are so great to the economy that most governments around the world are pumping in huge amounts to bail out their respective airlines.

“In all the countries, we have seen that capital is being pumped in, in the form of either government loans or bailouts or new equities. If you look at most of the airlines, a lot of them have had their governments pump in money,” observes Shahril.

In late February, MAG received approval from a UK court to allow it to start restructuring its commitments with aircraft lessors, including AerCap Holdings, Air Lease Corp and BBAM Ltd, involving lease commitments of 67 aircraft in the Malaysia Airlines fleet.

At the same time, MAG’s creditors agreed to the restructuring of RM15 billion worth of debts. Shahril says the lessors also agreed that lease liabilities would be paid only as and when the aircraft are used.

On its part, as the sole shareholder of MAG, Khazanah gave an undertaking to the creditors and lessors that it would inject RM3.6 billion over the next five years into the airline group.

According to Shahril, the Covid-19 pandemic has left every airline in the world essentially illiquid, and if they are left to fail, it would have a significant impact on other industries in the aviation ecosystem.

“It is an unprecedented disaster financially because of the major ripple effects to all the lessors who actually own the planes, the banks who had exposure through credit facilities or fuel hedging facilities, and also in terms of the aircraft manufacturers and the whole value chain of service providers and the jobs committed.

“So, for governments, it is a difficult position because you don’t just look at the amount of cash you are putting in, you are also looking from the point of view of what that cash does,” he says, adding that, owing to the large aviation ecosystem around Malaysia Airlines, the RM3.6 billion capital injection will also provide support to a slew of other industries, besides the airline.

Keeping national airlines afloat is an expensive process, he concedes, but to governments, the investments are necessary.

Shahril says: “There is no easy solution to this, no easy answers. But, ultimately, if you believe that Malaysians need to stay connected today in this Covid-19 world, there is a price to pay to ensure that the connection survives.”

He points out that, if Khazanah or the government does not commit to the restructuring plan and allows Malaysia Airlines to continue with business as usual, the cost of keeping the entire industry afloat would be four times more than the RM3.6 billion capital committed under the plan.

Nevertheless, it is an open secret that Malaysia Airlines’ financial turbulence did not stem from Covid-19; since the Asian financial crisis of 1997/98, the carrier has been roiled by one financial crisis or another.

Malaysians have lost count of the number of times the national carrier has had to be restructured over the past two decades.

Indeed, Khazanah’s latest restructuring plan is the second capital injection into Malaysia Airlines in the last 10 years, and comes on the heels of a 12-point restructuring plan for Malaysian Airline Systems Bhd (MAS) in 2014, wherein the sovereign fund ploughed in a total of RM6 billion to privatise and delist MAS and to recapitalise its new incarnation.

Under the 2014 plan, the goal was for MAS to achieve sustainable profits from 2017 — “sustainable” being the operative word here, as previous short bouts of profitability under previous restructurings turned out invariably to be false dawns. Because even though the carrier reported improvements in its financial metrics under the 2014 plan, achieving a net profit proved beyond its reach.

Shahril points out that the local aviation industry has been beset with oversupply and overcapacity for years, leading airline companies to lose money as they were forced to slash fares to entice passengers to fly with them.

“So, as a measure of cost, flights in Malaysia for a similar length was a factor of four to five times cheaper than in Japan or [South] Korea. That is just unsustainable, and that is why, even before Covid-19, other airlines were already losing money.

“And, in fact, if Covid-19 had not happened, one or two airlines would have gone under. Covid-19 just accelerated that process.”

Malaysia has five airline-operating companies serving a population of 32 million.

Only two of these companies are listed on Bursa Malaysia — AirAsia Group Bhd and AirAsia X Bhd (AAX). In the financial year ended Dec 31, 2019 (FY2019), AirAsia reported a net loss of RM285.96 million, compared with a net profit of RM1.7 billion in FY2018.

Its accounts include, however, the performance of its Indonesian, Philippine, Thai and Indian operations. Its Malaysian operations were positive on earnings before interest, taxes, depreciation and amortisation.

AirAsia’s FY2019 losses were the first year of group-wide net losses since the global financial crisis. Meanwhile, AAX has been in the red since FY2018 as it grapples with the long-haul, low-cost business model.

The other two airline-operating companies are Malindo Airways and Firefly, of which the latter is part of MAG.

A December 2019 waypoint report by the Malaysian Aviation Commission (Mavcom) states that Malaysian carriers reported an average operating profit margin of 0.3% in 1H2019 — much lower than the 2.9% in the corresponding period — because of rising costs.

The spread between revenue per available seat kilometre (RASK) and cost per available seat kilometre (CASK) also widened to -2 sen in 1H2019 compared with -0.7 sen in the corresponding period.

This is because, over the period, Malaysian carriers’ CASK had risen 5.9% year on year to 17.9 sen while RASK fell 2.2% y-o-y to 15.9 sen. The aviation commission warns that, if the situation persists, the profitability of Malaysian carriers will be at risk.

Khazanah has spoken of the need to deal with overcapacity in the local aviation sector. The restructuring of Malaysia Airlines helps, but the capacity issue needs to be addressed to ensure the sustainability of the industry, Shahril reiterates.

“The restructuring is finally giving us a chance to restructure a lot of the financial burden of Malaysia Airlines. It is now in a much better balance sheet and cost position going forward. But this also depends on the environment that is going to exist after Covid-19.

“So, if you have an environment after Covid-19 in which recovery is slow to take off or if, for instance, we allow again this unsustainable supply of seats and planes into the market, then you are just repeating what happened before Covid-19.

“Basically, all airlines operating in this space in Malaysia will have pressure on their revenue and sustainability.”

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