Fastjet - Turbulence during Takeoff

http://www.fastjet.com

fasjet logo

FastJet (LSE:FJET), has had a turbulent time since its change of name from Rubicon Diversified Investments. The company is a low-cost African airline backed by EasyJet founder Sir Stelios Haji-Ioannou through EasyGroup Holdings who recently upped their stake to 5.8% of FastJet's shares in issue. FastJet has seen its share price drop sharply from the highs since the name change to a current price of 0.995p/share having traded around 1p for an extended period of time. The group, which hopes to replicate the success of EasyJet, has posted encouraging figures for the last few months of flights, but there is no covering the risks associated with the business. At the current share price, FastJet has 3.05 billion shares in issue and a market cap of £30.4m.


The technical position of Fastjet is interesting. The shares did attempt a breakout from the 1p platform a few days back, but this was cut short on a news announcement by the company which I'll discuss later. The result is that the share price has fully retreated and actually fallen through the psychologically important 1p price. Unless the company releases positive news over the next few trading sessions, then I would expect the share price to remain hesitant and any upward movements may be sold into. The all-important level at the moment remains around 0.94/0.95 as this has been support over the last few months. If the price breaks through that level, then 0.75 would be the first target. However, that level would likely only be attained following negative fundamental news which has not yet occurred. The likely movement until news is therefore to linger around and just below 1p as it has done. A more bullish scenario would be set out by the shares quickly recovering lost ground and moving back towards 1.2p. That would set up as high as 1.5p as a target.

Aside from EasyGroup's stake, Lonrho (the company out of which FastJet was spun), inherited a 38.8% stake. This was originally much higher but it has been watered down through numerous equity dilutions. Due to the high-risk nature of FastJet, there is not much institutional interest at present. This has contributed to the price instability. What the company needs to do is prove that it's business model is profitable. If it can do this then insitutions may come onboard as the initial fledgling risk would be overcome. Furthermore, the penny share price tag lends the company to be exploited by momentum traders and speculators. If FastJet had listed at 10x its start price then it would be very difficult to see FastJet having shed the equivalent percentage. The company is moving towards changing this though through a recently announced share consolidation. The consolidation announcement is what recently capped off the price rise and led to a sharp retreat.

image courtesy of FastJet's website
The reorganisation was undertaken to allow FastJet to raise funds in the future. The company's nominal price is 1p and as the company writes "The issue of new shares by a UK company at a price below their nominal value is prohibited by UK company law". The reorganisation therefore bypasses this, as 10 current shares will be reorganised to form 1 share after it has been completed. This will raise the share price to ~10p and concurrently reduce the number of shares in issue to a more respectable 305 million. Of course though, the reason for this is to issue shares in the future and that is what has concerned investors (although quite frankly it is not a surprise). The company is still in a growth phase and therefore requires ongoing cash injections to meet CAPEX and OPEX until the company becomes profitable. The consolidation seems a sensible move.

If possible though I would urge the company to complete one large placing rather than more frequent smaller ones. At the moment, good news is being washed out by ongoing dilutions that put simply, aren't raising an awful lot. The current placings are being done through a Darwin Equity Financing Facility. Darwin is known to sell shares back into the market which depresses the share price. Furthermore, the gross proceeds of the last placing only amounted to £660k, which will have been less when net of expenses.

If, and it's a big if, the company can complete one large placing once the reorganisation is done, that is likely to be preferable as it allows investors to focus on the growth, rather than the financing of that growth. Suppose after the reorganisation the shares trade at 10p, if an open offer or placing is completed with a strategic investor/EasyGroup at 8p/share for 188 million shares, that would represent a 20% dilution, but it would fully-fund the company going forward, which is more important. There is a catch though. It should be done with a party that is not going to flood the market with the new shares - a contract could include anti-dilution rights to cater for that, but if it is done through a long-term investor, that would be ample assurance. In the absence of this possibility, the smaller placings are probably the best option.

That's all the financing out of the way - into the company itself. Currently FastJet operates domestically within Tanzania with routes including from Kilamanjaro to the island of Zanzibar and from Mwanza in the North East to the capital Dar Es Salaam at the coast. FastJet has also announced plans to fly to Zambia and Rwanda in the future, but before that, flights from Dar Es Salaam to Johannesburg will begin in late September and are expected to operate 3 times a week.

"The strategy is to create a series of airlines, all operating under the fastjet brand, and meeting identical international standards of reliability, safety and customer service. The flights for these airlines will all be sold on one website as a single brand, providing the consumer with a pan-
African airline experience, and the airlines with a reputation and sales platform across the Continent."


What FastJet offers is a low-cost alternative to current airlines with prices as low as $20/ticket net of charges for Tanzanian flights and $100/ticket net of charges for the South Africa route. As part of the company is also the legacy Kenyan Airline Fly540, which is loss-making. FastJet recently announced that it is seeking ways to restructure the business to make it profitable, but that won't have been helped by today's news of a fire at Nairobi's Airport through which Fly540 operates. Undoubtedly, the airport closure will impact upon FastJet's numbers, but the company did note that it can potentially benefit from route diversions, many of which use Dar Es Salaam as a central hub for East Africa. Any impact on the figures though are likely to be negligible.

Fastjet's current and planned routes
In early August FastJet announced it's July revenue figures which were pleasing to see. Passenger revenue exceeded $2.5m , which wen annualised gives an average revenue of $30m. However, the business is ultimately growing rapidly already so higher monthly figures should be expected, not least because July coincided with the holy month of Ramadan during which flight figures tend to be lower. The revenue rise amounted to a 10% increase month-on-month. Furthermore, load factors rose with the recorded load factor at 79%.

Chairman & CEO Ed Winter noted:
"These are excellent figures. They show the strength of our brand and the support we are receiving from the Tanzanian population. We expected the drop in travel over the religious period to be challenging, but our figures suggest that the fastjet proposition is gaining popularity. This only bodes well for the future."


The business model makes sense. The minimum wage in Tanzania amounts to around $530 annually so the domestic flights are competitively priced at $20 (+charges). Furthermore, minimum wages for specific sectors have been increasing rapidly as of late due to previous legislation, which will only help FastJet's cause. These short-term boosts coupled with the expected 6.5%+ annualised GDP change for 2013/14 bodes well especially since further catalysts in the form of natural gas development should keep Tanzania's economy buoyant for the foreseeable future.

Perhaps one of the most significant obstacles the company faces is to establish itself as the leading low-cost budget airline brand. With the absence of widespread Internet access, marketing is done primarily through mobile methods. However, the real issue is that unless FastJet expand quickly, other firms could take a share of the spoils. Skywise (a rival South African airline) also recently announced it's intention to fly routes within South Africa. In addition, in Kenya, established firm Kenyan airlines are launching a new low-cost airline named Jambo Jet which could cause problems for the Fly540 operations. FastJet are probably better off not competing directly with firms such as Skywise, but expanding into other routes. A large part of building brand awareness is, as trivial as it may seem, an attractive brand with an attractive logo. FastJet fits that in my opinion at least with the African grey parrot a comforting symbol.

On the contrary though, whilst it takes a while to build a brand, it only takes a few wrong moves to lose it, and that combined with African corruption remains a severe risk that has to be dealt with when investing in FastJet. Corruption is not necessarily part and parcel of operating in Africa, but undeveloped government systems can mean that cooperating with the governments can be a prolonged process. One thing that FastJet are trying to get changed are the tax rates that the governments impose upon travellers. These can dent how viable it is to conduct a low-cost airline model, so any resolution on this front would be beneficial for FastJet.

FastJet released it's month for the 18 months to December 2012, in May. Of interest were the following points:
- Loss for the period was $52.4m
- Net Asset Value of 0.96p/share
- Fastjet intends to reduce its current 90% equity shareholding in Fly540 Tanzania and is in initial discussions with a number of Tanzanian investors.
- CEO Ed Winter stated: "The next few months will represent a greater transformation for the Company as we endeavour to further implement and grow the fastjet business model. The Board is confident it has the right strategy and team in place to build a successful and profitable future for our shareholders."
- Auditing firm KPMG "indicated the existence of a material uncertainty" over the group's ability to continue as a going concern

In terms of broker ratings, there is only one and that comes from Beaufort Securities who have put a speculative buy rating on the stock with no price target mentioned.

I don't think there is any doubt that Fastjet is a high-risk investment, but having said that, it's also fairly obvious that if Ed Winter and the board can pull it off then it will be highly successful and potentially very profitable. Unfortunately though, low-cost carriers (LCC) in Africa have historically been unsuccessful. to name a few, Flamingo Airlines (owned by Kenya Airlines) was trialled as an LCC during the turn of the millennium, but this was eventually shut down with the charter deemed unsuccessful during it's time in Kenya. Another two, more recent skeletons that have been left include airlines 1time and Velvet Sky, both of which were liquidated in 2012. Therefore, it is no easy task for FastJet. However, the hub in Tanzania is possibly one of the wiser moves, with Dar Es Salaam acting as a major airport for a large stretch of East Africa.

There is also no denying the enthusiasm and intent that Ed Winter emanates. He has extensive experience in the aviation industry and this will only help in funding the future of FastJet. The potential for African aviation is widely known - in fact The International Air Transport Associations Chief Tony Tyler said: “Nowhere is the potential for aviation greater than on the African continent." The question will be whether one airline can conquer the continent or whether a fractured airline industry will remain pending economic and legislative change across the continent. One thing that FastJet must be careful to do is not alienate their passengers. The average Tanzanian ticket charge was stated as $70 (net of other charges), which is far higher than the $20 marketed price - whether this could become an issue is only really known by the board, but it is something to keep an eye on. There are, as outlined, a whole host of risks associated with FastJet, not least the high costs caused by the underdeveloped African aviation industry and other competition. However, the company has now taken off, and revenues are growing positively. Is now the right time to launch a LCC in Africa? The jury is still out on that one. No Rating.

7 comments:

  1. Hi El1te.

    Thankyou as always! Is fastjet a company you will be watching closely or is it too risky ? Interested to hear your final thoughts

    CraigJ

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    1. Watching, but want to see strong progress over a lengthy period of time

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  2. Thanks man, just saw your post on the forums thought i would have a look and I am impressed by your research. One thing I would aay for holders is to be wary over the Zuma's. Fastjet has ties with them through entering new countries by partnering with regional companies but the Zuma's are known to be shady in south africa!

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  3. Very nice review. Thanks for posting it. Covered all bases

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  4. Good review. Is a buy for me.

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  5. A good insight to Fastjet, investors should also look for more positive stuff going on behind the scenes.

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  6. Been watching FJET for a while, and have to say I agree with your report and sentiment; ever the optimist this is a strong buy for me.

    Anyone hoping for a quick scalp will get burnt, this is a slow burner.

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