Response to SriLankan Airlines management on the A350 lease cancellations

By Sanjana Fernando

As if by strange coincidence I received a response from SriLankan Airlines management on the same day my article on the A350 cancellation was published. Their article was titled ‘Why SriLankan cancelled the A350s, SriLankan has its say,’ and published in the same paper.

It says that in June 2015, the Cabinet of Ministers approved the decision to cancel the A350-900 leases. Apparently, the decision to terminate the leases was driven by a “detailed analysis” verified by two “internationally-reputed” industry consultants, which demonstrated that the A350 could not be operated profitably by the airline.

The analysis, they say, claims that the Revenue per Available Seat Kilometre (RASK) will be significantly lower than the Cost for the same Available Seat Kilometre (CASK).

Available Seat Kilometre (ASK) is a key metric used to measure the magnitude of airlines. It is calculated by multiplying the passenger seats in an aircraft by the distance of the route it travels. So the ASK of a 100-seater plane flying 1,000 Km is 100,000. The main goal of most airlines is to grow the ASK number (also known as increasing capacity). This is done by either increasing the number of aircrafts (seats) or by adding more routes (KMs). But SriLankan Airlines did just the opposite, when they cancelled the leases as well as terminating long-haul European routes. 

The RASK they say will be low mainly due to yield contraction due to competition driven by overcapacity in the European long-haul routes. Basically, saying that the ticket prices have become cheaper and there is not enough passengers to fly in these planes; a fitting argument for a poorly performing management led by a CEO who seems out of depth. Any other CEO would have jumped at the opportunity to operate brand new airplanes with more seating, to attract more customers at marginally higher yields (due to newer planes), and giving a good “blood” nose to any competition. Therefore, the revenue assumptions used by the management analysis do not seem accurate.

The CASK they say will be higher mainly because of incremental costs due to higher lease costs and maintenance reserve. The management goes on to say that the lease cost and the maintenance reserve would have resulted in a cost of $ 2 million per aircraft per month. This is factually fault. The lease cost of an A350 is $ 1.425 million per aircraft per month and this figure includes the maintenance reserve expenses. While a spare engine is a necessity to operate the A350s it certainly would not have a P&L cost impact of over $ 100 million (Rs. 15 billion) as claimed by the management.

In the airline sector your competition can smell your fear from a mile. If you run like a rat from every route then eventually you will be trapped and killed. That is exactly what is happening to SriLankan, who has taken a wrong strategic decision to pull out of the long-haul routes in order to concentrate on short-haul routes mainly to India. But with India’s LCC giant, IndiGo entering the Sri Lankan market in the next days, it will certainly kill any hope of the airline making a profit on those routes in the future. Their entry will not only expose the weakness in the SriLankan strategy but will also differentiate the real CEOs from the fake ones. 

Anyway, their analysis should not have been about the profitability of operating the A350s but should have been about the P&L impact under two scenarios: (1) cancellation vs. (2) operating A350s. But the decision to cancel was made in June 2015 and the negotiation with the lessor (AerCap) was in late 2016, so there was no way for the decision makers to have known that cancellation costs in 2015. Therefore, the argument that the decision to cancel was based on political needs as opposed to financial rationale, still stands tall.

I have also been informed today that in fact the dollar denominated loan taken to pay the AerCap fine has to be paid over four years and not 12 as per my initial analysis. This means that the impact on the P&L will be far worse than I had forecasted earlier. 

It should also be noted that the decision to cancel was “studied” and taken not by the management, the Board or the line ministry but by a higher Governmental body. The negotiations too were done by this same body, and the Board was not allowed to take part in the negotiations with AerCap. Although the Board wrote three letters requesting permission to talk directly with AerCap, it was never granted. The Board was also not allowed a say in the cancellation decision, and any dissent was quickly silenced by a political force at the highest echelon of power.

(The writer is a former Investment Banker from London with Mergers & Acquisition and Corporate Strategy experience. He has worked for a number of International companies in London including HSBC Bank and Goldman Sachs. As an Investment Banker in London he was also involved in the team that advised Emirates when they were looking to sell their stake in SriLankan Airlines at the time. He holds an MSc in Engineering from Imperial College London.)

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