Comments On AirAsia Hedging (Again), Forex Gains and Debt Bubble

Dedicated to snowball

From the posting How Good Is AirAsia's Latest Earnings?:

• Well, to be fair to Air Asia, I think the derivatives loss is their normal hedging loss from their 30% fuel hedge.
  
  The borrowings should be denominated in USD as Airbus itself sells its aircraft in USD and is very actively hedging their EURO-USD risk. Unless Air Asia try to do something silly like borrowing in yen to take advantage of the low interest( USD interest is really low for now too), I think we can assume a huge chunk would be in USD.
  
  But the debt is indeed worrying and I doubt it is sustainable. They are basically forecasting a very bright future for ASEAN tourism. It is a risky bet that have a high chance of going wrong.

To be fair... :)

Sorry, I hope I am not giving you the wrong expression that I have been unfair to AirAsia.

So do indulge in me. :)

Firstly, hedging.

Now I do understand many business have some sort of 'hedging' and many times, such hedging is needed but also prudent. However, as usual, in business, anything can and will happen and some instead of hedging, they speculated!

But AirAsia and it's fuel bet/speculation, it is one long mighty episode. It was a saga. Really! :D

Anyway, on March 2009, I wrote the following posting: Regarding AirAsia Fuel Hedges Again

Let me repaste the entire posting here. :D

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I took some time reading my old notes on AirAsia

On 26th November 2007, OSK wrote an report named Saved by the A320

• Outlook uncertain on fuel price. We adjust our fuel consumption based on the excellent showing in 1Q from the A320s. At the same time, we revised up our effective jet fuel price for FY08 to US$83 per barrel which puts pressure on margins. To note AirAsia has sold call options for WTI at US$82.60 per barrel with a knock in price at US$90. This means that if oil continues to stay above US$90, AirAsia will incur additional cost for its jet fuel. The company stated that it has taken steps to mitigate the impact in 1Q2008. Based on this premise, we revise up FY07 and FY08 forecasts by 35% and 9% respectively. Fair value is raised to RM2.41. Nonetheless, because AirAsia will suffer high jet fuel costs if oil remains above US$90 after 1Q2008, we downgrade it to a Trading Buy and may adjust numbers once greater clarity on 2008 oil prices are available.

On the same day, CIMB in its report named Profitability gains altitude with route maturity

• Risk from written call options reduced. As we highlighted in our 31 Oct report captioned Red alert as fuel surges past US$90, AirAsia has sold call options that threaten large losses if WTI prices hold above US$90. These derivatives have been partially neutralised by a separate hedging deal that offer AirAsia protection for a minimum of two months (Jan and Feb 08). We are relieved by AirAsia’s astute move since we expect oil prices to come off after the winter season.

6th December 2007. Published on Business Times

• AirAsia hedges half of fuel needs till June
  
  Hedging is a short-term solution to volatile fuel prices, and AirAsia will come up with a sustainable business model to further increase revenue, says its CEO
  
  Published: 2007/12/05
  
  BUDGET airline AirAsia Bhd has hedged half of its fuel requirement for the next six months, comprising 200 barrels at US$79.50 (RM265.53) each, in preparation for the projected fuel price hike next year.

The following is the version from Star AirAsia plans 50% fuel hedge

• “We are very comfortable with our hedging position,” Datuk Tony Fernandes told reporters at Lima 2007. “We are looking at covering ourselves at least 50% going forward. The price of oil is something you have to live with and build your business around.”
  
  The hedge consisted of a fixed swap and a put spread, an AirAsia official said.
  Singapore-traded jet fuel prices have risen 47% so far this year as global crude prices soared to nearly US$100 a barrel.
  
  “We have taken a hedge for 200,000 barrels, which will equate to about 50% of our consumption for six months,” Fernandes told a news conference later.
  
  He said the price was around US$79 a barrel.
  
  “We have got some put spreads in place. If we continue to feel that we're top heavy and most of this volatility is over, we'll tack down, and we'll do various hedges in between.
  
  “But we're not going to do 100% hedges and lock it in for the whole year because we just think it's too volatile,” Fernandes said.

The market was quick to spot. OSK wrote in their report Speculative Hedging?

• Sold Call Option at US$82.60 per barrel. The concerns surround AirAsia’s selling of a 150,000 barrels per month call option at US$82.60 per barrel with a knock-in price at US$90 per barrel between January 08 to June 2010. If oil were to sustain at US$100 per barrel, AirAsia could be looking at a RM100m loss per annum. The sale of the call option was done as AirAsia was expecting oil prices to retreat in 2008.
  
  Short position covered by new long positions. AirAsia has since covered its positions by buying Call options for 350,000 barrels at US$82 per bbl and also 200,000 bbl per mth at US$79.50 per bbl between January to June 2008. It also said that it has room to negotiate on the Short Call options every 6 months. Given these developments, we do not factor in any losses from the fuel hedges at the moment.

RHB compiled a table in its report that same day.

• In our earnings model, we assume AirAsia’s jet fuel cost to average at US$75/barrel in 2008. Based on our sensitivity analysis, for every US$1/barrel increase in our jet fuel price assumption, AirAsia FY12/08 net profit will decline by RM12.3m or 5.2%. Ceteris paribus, AirAsia’s breakeven jet fuel cost is estimated at US$94-95/barrel. Our benchmark FOB Singapore spot jet fuel was last traded at US$107.30/barrel.

Crude oil of course rose.

My favourite Business Times article.

• AirAsia: No more bets on oil price
  
  There has been significant selling from AirAsia's foreign shareholders and this is 'related to AirAsia's fuel-hedging policy', says an analyst
  
  Published: 2008/01/11
  
  AIRASIA Bhd, Asia's biggest discount carrier by fleet size, will stop making bets on the price of oil, after incorrect forecasts contributed to a 16 per cent slide in shares over the last month.
  
  "It's a nightmare because the volatility is crazy," chief executive officer Datuk Tony Fernandes said in a Bloomberg Television interview on Thursday. "We took a bet that oil won't go above US$90 a barrel and it has and it's staying there."
  
  Crude oil rose to a record US$100 a barrel earlier this month instead of falling as AirAsia had predicted. If the price of oil remains at that level, earnings could fall by RM8.45 million a month because of speculative hedging, according to Christopher Eng, an analyst at OSK Research Sdn. in Kuala Lumpur.
  
  There has been significant selling from AirAsia's foreign shareholders," Eng wrote in a January 9 report. The drop is "related to AirAsia's fuel-hedging policy, which some parties considered excessively speculative."
  
  Fidelity International cut its stake by 9.8 million shares as of December 24, according to Bloomberg data.

ps: For those who were fascinated by the recent bold privatisation intent from AirAsia, try reading this OLD article AirAsia has no plans to go private, says CEO

The market of course focused on that BOLD statement from AirAsia.

• We took a bet that oil won't go above US$90 a barrel and it has and it's staying there."

On a Business Times article four days later.

• AirAsia: We don't speculate on fuel prices
  
  Its CEO says AirAsia approaches fuel hedging carefully and has always maintained a conservative stance which resulted in positive contributions from its past fuel hedges
  
  Published: 2008/01/15
  
  AIRASIA Bhd yesterday clarified that it has never speculated on fuel prices in the past and will not speculate on fuel prices going forward.
  
  Responding to reports that AirAsia adopts a fuel hedging strategy that is excessively speculative, chief executive officer Datuk Tony Fernandes said the airline's strategy has always been to hedge fuel requirements whenever an attractively priced structure is available.

The above can be read in full on Bursa website AirAsia PR_Clarification on Fuel Hedge_15Jan2008.doc

Of course many opinioned that AirAsia speculated. Here is a passaage from thge weekly edge, 14 Jan 2008: Big Money: Did AirAsia speculate on oil prices? By P Gunasegaram

• It means AirAsia sold someone the right to pay US$82.60 per barrel of oil to take effect from January 2008 to June 2010, a period of 30 months, when the price of oil per barrel reaches US$90 per barrel. As we all know, oil crossed US$100 per barrel recently, which means AirAsia stands to lose US$17.40 per barrel at US$100 a barrel for whatever amount it contracted to sell during the period.
  
  Importantly, AirAsia, through that call, basically bet that oil would not cost more than US$90 a barrel. Why? Perhaps it was part of a complicated hedge to fix its oil prices, but at the end of the day, it was not.
  
  AirAsia deputy group chief executive Datuk Kamarudin Meranun told The Edge (see news story) that the net effect of all the complicated hedging was that the company had covered all its positions but that it will have to pay the market price of jet fuel.
  
  In other words, despite all the hedging efforts that AirAsia made, it did not manage to hedge an exposure to rising oil prices — a basic plain vanilla hedge would have done that. That is likely to have come about if its hedging policies did not only hedge but took speculative positions based on its own view of which way oil prices would move.
  
  Kamarudin himself believes that an airline company should not trade or speculate in oil.
  
  Unless it can show us otherwise, AirAsia seems to have speculated — it did not merely insulate itself against rising jet fuel prices but took positions based on its reading of the oil market.

Few days later on an article with Jose Barrock on the Edge. (the Edge is revamping their website - which means I cannot post the source links yet)

• 21 Jan 2008: Corporate: AirAsia: No glitches in hedging policy
  
  Last week, Fernandes made an announcement to Bursa Malaysia that the company's hedging policies were not speculative as reported.
  
  "Every hedge has a cost. One would have to evaluate the appropriate benefits… In the history of AirAsia, we have beaten the market (hedging the price of oil successfully) every year. We are sophisticated hedgers; we are risk-averse as a company.
  
  "We are the only airline that took 12-year hedges on interest rates swaps on our planes. We did it (hedging) in US dollars but now we are swapping it with our earnings. We fixed our engine contracts for 22 years — the only airline to do that. We try and take out variability which we can't control," Fernandes told The Edge recently in response to articles that the low-cost carrier was involved in unhealthy hedging of aircraft fuel.

Sophisticated hedgers?

The IRS swaps is now losing money. How much exactly? I have no idea.

Fast forward.
November 2008. AirAsia removes fuel surcharge, offers free seats

• He noted AirAsia does not hedge its fuel purchases like other airlines do. To protect against the possibility of prices going up, some carriers make advance orders at current prices.

AirAsia does not hedge its fuel purchases?

Rest is history.

See AirAsia Reported Massive Losses Again!!, Comments On AirAsia Exceptional Losses and Reply To Comments On AirAsia Exceptional Losses

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How? Was it hedging? Sorry but in my flawed opinion, AirAsia speculated terribly on fuel and most importantly, the boss made the bold statement "NO MORE BET ON OIL!"

Regarding foreign currency loans.

You said:

• The borrowings should be denominated in USD as Airbus itself sells its aircraft in USD and is very actively hedging their EURO-USD risk. Unless Air Asia try to do something silly like borrowing in yen to take advantage of the low interest( USD interest is really low for now too), I think we can assume a huge chunk would be in USD.

I see no reason to say that your assumption is wrong.

However... end of the day, it's an assumption.

Two things. One can always ass-u-me correctly but one can also ass-u-me wrongly. That's why we keep saying ass-u-me means making an ass out of u and me. Secondly, the obvious way to solve this is the logical one, which is to get AirAsia to be more transparent with its foreign currency borrowings. Such borrowings causes huge swings in forex gains and forex losses. Now if AirAsia states in a transparent manner, the investing public does not have the obligation to make an ass out of themselves, yes?

Lastly, the size of AirAsia debts. :)

Blogged previously: Would You Define AirAsia Debt As A Bubble?

How?

Many thanks for your previous time. :)