Japan Airlines: Japan's GM

Japan Airlines (JAL) is Japan’s flagship airline. JAL is the carrier of choice for Japanese government officials, be they the prime minister or Diet politicians on overseas junkets. But JAL is in deep financial trouble.

As a reflection of the national flagship’s finances, Standard & Poor's is considering downgrading JAL and subsidiary Japan Airlines International Co’s L-T corporate credit and senior debt ratings. JAL and its 100%-owned subsidiary are already rated a speculative B+, and a downgrade would drop this by more than one notch. Ratings would already be poorer if it were not for implied government support for the carrier. Now that the DPJ is in power, even implicit government support is being reviewed.

The rating agencies are carefully reviewing the stance of financial institutions currently supporting JAL, medium-term business plans being drafted to maintain this support, as well as transportation ministry-prodded negotiations with foreign carriers about possible capital tie-ups. American Airlines Inc., British Airways Plc and Qantas Airways Ltd. have made a joint offer of assistance in a bid to supplant Delta Air Lines Inc. The foreign carriers are reportedly offering extensive financial assistance, such as debt guarantees, introducing JAL to banks, providing restructuring consulting services; merging some of the companies' offices; and adjusting the numbers of their transpacific routes. In addition, American Airlines is considering investing in JAL, possibly taking a stake worth several tens of billions of yen.

JAL is currently under a state-supervised rehabilitation process. Incoming transport minister Seiji Maehara has publicly stated that bankruptcy is not an option for JAL, as he apparently sees JAL and All Nippon Airways (ANA) as the two pillars of Japan’s aviation industry. Maehara has also said he wanted to scrap the Transport Ministry-affiliated panel designated under the previous government to review the plan. The uncertainty lies in the fact that the DPJ and Mr. Maehara have been vocal critics of the collusive relations between the Liberal Democratic Party and business. Senior management from JAL ,ANA and the transportation ministry were all unable to gain an audience with a senior DPJ lawmakers immediately after the Aug. 30 general election swept the DPJ to power.

In this holiday-shortened week, transport minister Maehara will reportedly meet with Haruika Nishimatsu, president of JAL, senior JAL officials, personnel from the Development Bank of Japan and the vice ministry of the transport ministry to review the Company’s restructuring plan before it is finalized by the end of this month.

JAL is beset by a raft of intractable problems, including a crippling debt load, heavy pension obligations and the negative effects of spreading swine flu infections. JAL’s current turnaround plan draft reportedly aims to eliminate more than two dozen domestic flights and shed nearly 7,000 jobs, but creditors are skeptical about the plan’s effectiveness. The carrier told creditors it needs JPY300 billion in new capital to stay afloat through the current fiscal year (FY09). Private lenders however have been dragging their feet on fresh loans unless the company implements radical restructuring and wins financial aid from the government,

The guessing game on the fate of JAL is likely to continue until the new government clarifies is policy on the issue.

Details of the carrier’s revival plan due out late this month ostensibly include the ending of flights to Rome, Mexico City, Amsterdam, Brisbane, San Paulo, Kaohiung, Hanzhou, Xiamen and Qingdao. Services at seven domestic airports ostensibly will be discontinued, and partial cutbacks initiated for other cities—including 21 international routes and 29 domestic routes—or essentially all money-losing routes.

Also reportedly included in the plan are reduced pension benefits to current and former employees as well as a spreading out of PFO (pension fund obligations) over a longer period, to generate an extraordinary profit of JPY88 billion for the fiscal year ending March 2010. JAL hopes to lower the benefit rate to below 2% for 17,000 current employees.

The government-owned Development Bank of Japan and Japan's three top banking groups already lent JAL JPY100 billion yen in June. Government guarantees covered part of the DBJ's portion of the syndicated loan. This financing however was little more than a band-aid for the national carrier’s problems.

JAL’s megabank lenders seem to believe that JAL has not fully committed to restructuring. Concerned, they are urging the airline to take more drastic restructuring. The Transport Ministry under the LDP regime however had maintained that a major route restructuring would run counter to national interests, saying that the top priority should be maintaining flights to remote islands and between regional airports and foreign cities. Thus the restructuring of JAL, as with GM in the US, has become a bit of a political football.

JAL has historically had rocky relationships with its union, as represented by the Japan Federation of Aviation Workers' Unions (Kokuren). Kokuren comprises 53 aviation unions, including 21 from JAL and its affiliates. The carrier is likely to face fierce labor protests in its effort to whittle down annual operating costs 30% through an early retirement program, cuts in flight services and the use of smaller airplanes. Moreover, it is already the world's worst major operator by almost any metric you care to mention. JAL's gross margins are about half the global peer group average; none can compete with a six-year average return on equity of minus 17 per cent. Net debt to equity was 346% at the end of March, comfortably the worst in class. Management, contemplating the latest in a series of cuts to staff, hubs and wages, expects more red ink this year.

Thus even if JAL can secure the necessary capital to survive the current fiscal year through March 2010, concerns will still linger about the airline's capital needs in the next fiscal year and beyond. The continued rise in fuel costs should also represent ongoing pressure on margins. The Company lost JPY82 billion last year, and is expected to lose another JPY108 billion in ordinary profit this year.

The stock has completely missed the rebound rally to date, and since the stock prices is already so depressed, could see a nice bounce on news of a credible restructuring program as well as an agreement with foreign carriers for a possible capital infusion. This rally however is likely to run out of gas between JPY200 and JPY220, as there is a substantial amount of cumulative trading volume in this zone that represents potential selling pressure. From this standpoint, the current stock price represents a nice short-term 50%~80% trading turn, but don’t overstay your welcome.