Amid a storm of speculation over its future, Japan Airlines (JAL) announced dismal first-half results as it entered out-of-court mediation with its creditors over its multi-billion dollar debt burden.
JAL announced a ¥95.7 billion ($1.1 billion) operating loss last Friday for the first half of this financial year which ended September 30. That's down a whopping 417% from a year earlier when it posted an operating profit of ¥30.2 billion. Even JAL's chief financial officer Yoshimasa Kanayama was quoted saying the results were "extremely bad".
Though, few were surprised by the airline's results. Bank of America Merrill Lynch analyst Yasuhito Tsuchiya wrote in a report that the airline's earnings "about matched" the bank's estimates and that he expects JAL's full-year earnings to be revised down.
What is surprising is that this loss-generating airline is at the centre of a veritable battle for Tokyo's skies with the world's two largest airlines -- American Airlines and Delta Airlines -- pitted against each other. At stake is JAL's hub at Narita Airport, a critical North Asia node in the web of global alliances encircling the world.
Tokyo is important to the global alliances because of its strategic location in their route networks. Historically the waypoint for most flights between the US and Asia, Tokyo's Narita Airport is home to four airline hubs -- ANA, Delta (by way of its 2008 acquisition of Northwest Airlines), JAL and United Airlines -- each with their own alliance affiliations (ANA and United are part of Star, Delta Skyteam and JAL Oneworld). A shift by JAL to Skyteam would seriously upset the alliance balance at Narita and Oneworld's access to much of North Asia, especially for American Airlines' passengers connecting through the airport from the US.
"Let me be very clear," said Gerard Arpey, chairman and chief executive of American Airlines, in an announcement. "JAL is a highly valued member of Oneworld...[and] we are committed to maintaining and strengthening that partnership."
Responding to questions from analysts during the airline's third-quarter earnings call, Arpey said: "We and our Oneworld partners have I think a very deep and longstanding partnership with JAL that is today producing hundreds of millions of dollars of value for them... I think that JAL and its stakeholders recognise that an alliance switch would be burdened by excessive financial and regulatory execution risks during the critical initial phase of its restructuring."
Ongoing US-Japan open skies talks only make JAL a more important partner to US carriers. Under the current proposal, access for US airlines to Tokyo's close-in Haneda Airport, due to open a fourth runway next year, is limited and does not include fifth freedom rights to fly-on to other destinations in Asia from the airport. JAL's prominent status at Haneda is, in the words of one Gerson Lehrman Group expert contributor, "one reason [American and Delta] are so keen now to pursue JAL".
JAL is Japan's former government-owned airline. It was privatised in 1988 but retains much of the vestiges of a state-owned carrier -- a bloated bureaucracy, an inefficient route network and a heavy pension burden. By contrast, the airline's main competitor, All Nippon Airways (ANA), is a smaller, more nimble carrier that's come from private-sector roots.
ANA posted an operating loss of ¥28.2 billion for the first half.
Top of mind for investors in JAL is not its earnings -- those were expected -- but how its debt situation will be resolved. "JAL is due to repay about ¥280 billion in contractual obligations over the coming two years, added to which it has onerous off-balance-sheet liabilities such as unrecognised obligations and unpaid lease fees," wrote Tsuchiya.
At the end of its 2009 fiscal year, JAL had ¥1.44 trillion in outstanding interest-bearing debt including ¥331 billion in unrecognised pension benefit obligations, according to Nomura Research. In addition, its available cash had dwindled to only ¥487 billion, nearly half of what it was at the end of 2008.
JAL decided to enter preliminary discussions with the Japanese government's Enterprise Turnaround Initiative Corporation (ETIC) at the end of October to work out a comprehensive rehabilitation plan that is likely to include short-term bank financing, capacity cuts, employee layoffs, a solution to its pension burden and a restructuring of its non-core assets. Despite its involvement, analysts expect the government to have a smaller role in the airline's restructuring then it has had with corporations in the past.
"The government appears unwilling to provide a solution without the burden being shared by JAL's debtors and its pension holders, and probably without the company being radically reorganised," wrote Moody's analysts Brian Cahill and Shinsuke Tanimoto.
In addition to announcing dismal earnings, JAL said it was applying for "alternative dispute resolution" -- or ADR, an out-of-court mediation process with creditors -- last week. Analysts predicted this is a way for the airline to temporarily suspend debt payments while it finalises its restructuring plan. The plan is expected to include loans from Japan's major banks, including the Development Bank of Japan, a capital investment from a foreign airline or financial investor (American Airlines has reportedly been in talks to team with private equity firm TPG) and the previously mentioned structural changes in the airline's management and operations.
The outcome of JAL's request for government assistance and a restructuring plan is not expected before the end of the year.
Many plans have been floated on the future shape of JAL. One from the Centre for Asia-Pacific Aviation proposed that the airline create a "dual brand" structure similar to Qantas and its low-cost subsidiary Jetstar. This would allow JAL to reduce costs on thinner routes and help bolster its international presence with the subsidiary flying to markets that cannot support mainline JAL services. Another solution, outlined by Tyler Brulé in his column in the Financial Times, took a similar but different tack -- proposing the airline turn its domestic operation into a "service-minded, dignified low-cost carrier" and repackage its international operation as a more sophisticated product appealing to higher-spending leisure travellers and small business owners. The clincher though was Brulé's description of a proposed new apologetic logo for the airline -- a rhinoceros with a JAL logo on its back.
In the end, JAL will most likely remain part of Oneworld and take American Airline's small capital investment. The airline's president Haruka Nishimatsu was quoted last week saying it "makes more sense" to stay with the alliance. The costs of extricating itself from the alliance and then seeking regulatory approval for a new tie-up with Delta -- US regulators would not look highly upon JAL and Delta's combined 60% US-Japan market share -- would be costly and onerous.
Addison Schonland, partner at aviation consultancy Innovation Analysis Group, actually sees the whole effort by JAL as simply a way to get government funding. "With [American and Delta] in play, JAL's management was able to go to the government to claim it needed help or foreigners would take over the company... JAL's management has therefore been able to suddenly create demand where there should be none," he wrote.
The airline's share price on the Tokyo Stock Exchange closed at ¥102 per share yesterday, down nearly 52% year-to-date. BoA Merrill analyst Tsuchiya expects JAL's shares to fall to the ¥80 range by the end of the year.
