Modernization of PIA fleet

Published November 18, 2002

The national flag carrier, the Pakistan International Airlines (PIA) has signed, on 30th October 2002 at Islamabad, an agreement with Boeings, USA, for purchase of eight new Boeing 777 planes, comprising three Boeing 777-200ER, two Boeing 777-200LR and three Boeing 777-300ER, for use on its long haul routes. The deliveries are said to start in December 2003 and would continue through 2008.

The new aircraft are expected to help the PIA to earn more with better and competitive service. The initiation of the modernisation plan is a big step in the right direction. All this has been achieved through continued moral and financial support of the government.

The PIA management claims to have performed well and brought the airline back to profitability through a number of remedial measures. However, in spite of the optimism, the airline is not yet fully out of troubled waters.

There are a number of difficult challenges ahead such as consolidation of profitability, strengthening of financial position, arranging of suitable financing at reasonable costs for financing the new planes, and other important areas having strong bearing on the airline’s operations.

The airline industry in general is not doing very well and this phenomenon can also affect PIA to some degrees. Realizing the conditions at present obtaining in PIA and the need for continuation of operational reforms, the government has already extended the service contracts of the top PIA bosses. This should encourage them to work single-mindedly for continued improvement of the airline position. In the context of meeting the challenges successfully by PIA, this paper offers a few suggestions to the PIA high-ups and the government for consideration.

Profitability: The airline management, on the basis of un-audited accounts for the past few months, has been claiming turning the airline operations profitable. The data released for the period January-September 2002 show a pretax profit of Rs1.4 billion. The management claims would stand validated, particularly by the shareholders and by the existing and prospective creditors, after the audited accounts for the year 2002 confirm profitable operations. Being at the fag end of 2002, this should not be difficult provided the management maintains high overall operational performance along with continuation of the reforms process.

The auditors might be approached with the request to finalize the audit for the year 2002 within 2-3 months of 2003. April 2001, when the present management took over the airline, it was on the verge of financial collapse. The new management assessed the resources and initiated the reforms process. The measures reportedly included cutting measures, executing efficient revenue generation plans and re-adjustment and re-scheduling flights. It may be noted that, the airline’s revenue generation dropped after 9/11. Moreover, denial of flying over Indian airspace affected its flight frequency causing a serious cut in revenue. On the other hand, return of several airlines from Pakistan provided some space to the airline.

On overall basis, the airline operations, though profitable, need to be further improved. Other areas needing particular attention are increasing revenue from freight and rationalizing expenses on aircraft fuel and oil, salary and wages, landing and handling charges, maintenance and overhaul and the financial charges. Perhaps it is about time that the cost and utility of the services procured from out-sources is also reassessed.

Financial position: The financial position of the airline, as reflected in the audited accounts for the year 2001, is rather weak. Current assets are only Rs11.343 billion as against the current liabilities of Rs28.484 billion. Accumulated losses are shown at Rs12.859 billion. The auditors also have observations on some of the important aspects of the airline. In such a situation, the management task of rehabilitating the airline is not at all easy.

Restoring the financial health might take a number of years. However, the financial health could be restored in the next two years with continued profitable operations and substantial government support. It may be noted that due to present weak profitability and financial position, it will be difficult for the airline to raise loans for fleet modernisation at reasonable rates and fees. Every creditor will seek premium over the normal rates due to the weak balance sheet of the airline.

In order to improve its borrowing position, it is felt that the management must act extra hard to bring out the annual report 2002, with clean report from the auditors and also showing amicable relations with existing creditors. It is felt that the financial support announced by the government, if suitably reflected in the airline’s annual accounts 2002, will give more confidence to the creditors as to the viability of the airline. A strong balance sheet and good cash generation capability reflected by the audited accounts 2002, would surely make substantial difference in the attitude of the creditors as well as in the final cost of fresh borrowings needed for fleet modernisation.

The management might consider getting the airline rated by reputed rating agencies. With better rating, the airline might be able to raise large loan (and equity funds) at reasonable rates and in the desired amounts. For this purpose, the rating agency may require the audited annual report 2002.

Agreement with Boeings: As stated earlier the airline has signed an agreement with Boeings for purchase of eight new Boeing 777 planes. Deliveries are expected to start in December 2003 and completed by 2008. It is to the credit of the present management of PIA that it took first practical step for replacement of some of the aging planes. However, the real task has just begun.

PIA may have to remain in constant liaison with Boeings as to the physical progress for building the planes as per the agreed specifications and delivery schedule. Tied to this is the task of mobilizing suitable funds to pay to Boeings for the new planes as per the agreed schedule of payments. Both these activities are important for the success of the fleet modernisation plan. The management may like to consider appointing full time teams of dedicated officers to properly handle the assignments spread over the next about ten years.

Smaller planes: Marking induction of another Boeing 747-300 aircraft acquired from Cathy Pacific to the airline’s fleet a few days ago, the managing director told newsmen that this addition would give a new look to the national carrier and that these aircraft would be operated on the US and European routes. It was also said that the airline’s modernisation plan will be taking shape with the arrival of first new Boeing 777 aircraft in December 2003, being first of the eight new 777 aircraft acquired under a purchase agreement recently signed by PIA with the Boeing Company. The newsmen were informed that the airline would replace smaller aircraft like Fokkers with induction of about seven ATRs aircraft by June 2003 to be acquired on ‘dry lease’. PIA will also acquire four A300-600 Airbus, some 8-10 year old, on lease to replace existing aging airbuses. The entire fleet of 11 Fokkers would be grounded by December 2003.

Like the bigger planes, selection / procurement of the smaller planes on attractive terms is not easy. It is hoped that the experience gained earlier for the bigger planes has been fully used for selection of the smaller planes and the finalization of the lease arrangements in a transparent manner. One would wish that the airline had opted for acquiring at least some of the smaller planes that were brand new.

The replacement of the smaller planes is particularly important to facilitate travel to the northern areas, coastal cities as well as the cities in the interior of the country. These routes might not be the most profitable but these are important for providing relief to the people from the far-flung areas, with poor alternate means of transport.

Financing the fleet modernisation: PIA probably has been in touch with various creditors for financing part of the cost of larger aircraft for the long haul to USA and EU countries. Exim Bank, as per practice, first agrees in principle to consider the deal up to 85 per cent of the total amount involved in purchases from USA. Now the airline is expected to move its application with the Exim Bank (EB) seeking around $350 million for the purchase of first three Boeing 777-200ER, of which delivery will start by December 2003.

Additional foreign funding from the EB or other sources shall have to be arranged in due course for financing remaining two sets of aeroplanes for which orders have been already booked with Boeings.

Exim Bank has standard charges for providing insurance and repayment guarantee to Boeings, all charges being to the account of PIA. Now, it is up to the airline to decide whether to avail loan from EB or other sources; and in what combination. Main interest cost, guarantee/insurance commission, fees payable to the financial advisors, travel and other costs involved, etc. all add up to form the financing cost. Comparison of the overall financing cost from various sources and other factors such as time and place for negotiations of loan terms including credit agreement, complexity of the documentation, security, arbitration matters, etc are must in such deals. The airline shall have to do lot of homework to be able to get the best deal.

Pakistan is lucky to have accumulated foreign exchange reserves of nearly $10 billion at this point. The State Bank of Pakistan is looking for profitable venues to invest part of these reserves. It is felt that the SBP might consider extending a credit line to a local bank such as the National Bank of Pakistan with a view to finance large acquisitions such as the purchase of Boeing planes by the airline under the fleet modernisation plan approved by the government.

It should be a straight long-term loan by the NBP to the airline under terms and conditions to be determined in consultation with the SBP. Perhaps the airline and the country both would be better off in the long run through this arrangement.

The airline has also recently mandated the UBL, Citigroup and the IDB to arrange $150 million that may be utilised to pay the first tranche of advance payment to Boeings towards the purchase price of eight new Boeing 777 aircraft. The structure of the facility as reported in the press appears somewhat complicated. It will be one-year facility of $ 85 million to be replaced by a three-year facility of $150 million.

The three-year facility of $150 million will be in the form of an ‘Ijra’ facility, based on Islamic mode of financing. In the $ 85 million facility, the UBL and the Citibank/Saudi American Bank have underwritten $45 million and $40 million, respectively. The Islamic Development Bank has agreed to underwrite $ 70 million in the three-year facility. Reportedly, it is the first time that IDB has formed a partnership with a local and foreign bank based in Pakistan. This is also the first major deal for the United Bank after its privatisation.

The airline has made substantial investments in some hotel properties and other non-core businesses. It might consider raising some of the needed funds through disposal of some of such investments. This should reduce the amount to be borrowed and thus there may be savings in the overall servicing of the debt.

Sometime ago it was in the press that the government, while approving the fleet modenisation plan, had agreed to extend $150 million to the airline as part of its equity. Use of this $150 million from the government seems much better option for making advance payments to Boeings for the eight planes booked recently as compared to the borrowings from the UBL and other banks as mentioned above.

Borrowing at reasonable rates and costs is as difficult as the procurement of used planes, if not more. Keeping in view the needs and the timing of funds, borrowing plan is developed. PIA may decide to handle all financing activities in-house through its dedicated team or might decide to engage experienced bankers through a mandate to raise the needed funds. In either case, lot of work will be required to be handled within the airline.

In connection with the mandate, reputed and experienced creditors are contacted for indicative bids or expression of interest in helping raise the required funds. The creditors are then short-listed, with whom serious negotiations are held for the mandate. Knowledge of the creditor practices and policies comes handy in such situations. The higher authorities should clear final draft of the mandate before it is signed and the banks are given the go-ahead. It is felt that the above is a transparent and proper way for raising large resources. Presumably, PIA has followed a proper process in the award of the present mandate to UBL and others.

Government support: The government has shown full confidence in the new management by providing financial and policy support, facilitating issuance of TFC’s of Rs15.4 billion to repay overdue liabilities and repayment of bridge loans, relief of mark-up on restructured debts/TFC’s by way of equity contribution and additional equity of $150 million spread over a period of three years for fleet modernisation.

The above is a major relief. The ball is now in the court of the PIA management and staff to rehabilitate the airline to its past glory. The airline, instead of borrowing from the local banks, should have prevailed upon the government to contribute equity of $150 million in one go now so that PIA could make advance payments to Boeings for eight new planes. This approach could have allowed PIA management sufficient time to appoint suitable staff and bring on board its specialized team to mobilize funds for fleet modernisation spread over the next decade. On open-sky policy, the airline might take up with the government if the foreign airlines are currently taking undue advantage of the situation and if PIA is not getting reciprocal treatment from the foreign countries.

Competition: The DG, the CAA at the time of first test flight PK-385 on 5th November 2002 at the new Allama Iqbal International Airport reportedly stated that Lufthansa, Swiss Air, British Airways and airlines from the Central Asian States have shown interest to start their operations from Lahore.

This means more competition and challenges to airline employees and the management. The airline at the moment badly needs the new planes. On fair competition, it can be said that PIA management and the staff have the will and the experience to fight it out with the competitors and one should not be worried much on this account.



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