El Al has no direction or purpose

El Al

Who really calls the shots at the Israeli carrier, and what time bomb is concealed in its balance sheet, asks Avishai Ovadia.

"The homiest in the world," is one of El Al Israel Airlines Ltd.'s (TASE: ELAL) slogans, and I admit they hit the bulls-eye. We fly El Al, pay a few more dollars than for a low-cost flight, and feel like we do at home in Israel.

Indeed, as I see it, El Al is a microcosm of Israel - a company with no clear purpose or agenda, a divided and tribal company with no real master, a survivor company. Companies are supposed to make profits - that is the main purpose of doing business, especially listed companies, but El Al is not really sure that this is its main purpose. It seems like the profit for its workers, especially the pilots, is a more worthy goal. El Al has been surviving since it was privatized in 2003. It makes profits in some years, but it is an accidental and not very solid profit - a profit that can evaporate instantaneously.

El Al is a company that is unable to earn a substantial profit - it was even unable to take full advantage of the fall in oil (and jet fuel) prices. It is simply extorted by parties at home and carries a burden of past commitments and debts, and that makes sure that no profit is left for the shareholders.

The main actor here is the workers - more than El Al creates value for its shareholders (profit in its profit and loss statement), it creates salary for its workers (salary expenses are quite a large multiple of its profit). From their perspective, the workers are justified - their goal is to maximize their profit; what do they care about the shareholders? On the way, however, they cause damage to themselves. El Al, a fat and inefficient company, will have a hard time being a significant player in a competitive aviation market. I emphasize that there is no real problem with most of the workers. The problem is with workers who earn as much as the CEO and behave like children lying to the doctor in order to avoid an exam at school - yes, the pilots, who took us (the public) as hostages, and played sick (in order to frighten the management) and all sort of other third-grade games for the purpose of increasing their salaries, and they succeeded.

With workers like this, who in effect control the company, the business cannot really make a profit. It is not only the workers, however, who eat away at the profits. El Al is a company that lives on the edge. Civil aviation is by definition a constant risk - recently, some airline somewhere in the world has been going bankrupt almost every week. This is very risky business because of the enormous competition, mainly from airlines that provide especially low-cost flights.

Something will always eat up the profit

The risk is reflected in the reports. In order to be El Al, you need a huge amount of financing. The company has a $1.9 billion balance sheet total and $300 million in equity. This is leverage on a big scale, but it is not exceptional in the aviation industry. Nothing can be done about it - airplanes cost a lot of money.

The value of the airplanes in the company balance sheet (rounded off) is about $1 billion. This is the cost of the airplanes after appreciation, but the fair value of the airplanes does not justify this value. According to the price lists in the industry, the fair value of the airplanes is $200 million less than the cost in the books (according to an examination of El Al in March 2017). There is a kind of potential loss here amounting to $200 million, and before I describe how the accounting builds a wall around the cost in the books (and prevents depreciation), think about the company's management, which lives in perpetual fear that it has a bomb ticking in its balance sheet that is liable to explode at any moment and cause a huge loss. In my opinion, these managers will try to reduce this risk the moment they have reserves (profits). They may try to rethink and record a provision for a decrease in value (relatively rare), or to replace the air fleet, renew it, and other actions that will reduce the gap between the value and the cost in the books.

It therefore follows that in the case of profits, there is a pretty good chance that they will evaporate, given salary demands, provisions for the planes, and other profit absorbers (currency changes, hedge deals, provisions, claims, and so forth). It is true that things may be different in the coming years, but since the airline held its IPO, it has not generated value for its shareholders - only for the workers. This is a fact, and the truth is that even if you go further back, it was a concern that did not generate value even before it was privatized - a concern that simply lived under state sponsorship.

The conclusion for readers of the reports and investors (existing and potential) is that at El Al, even if there is a profit-encouraging event, it is not the way it appears at first sight, but much less.

One example: three years ago, with the fall in oil prices, followed by the price of jet fuel, the company's expenses dropped sharply. Jet fuel is a huge expense in the company's reports, (currently 20% of revenue turnover, previously more substantial), and when its price is halved, it should generate a boom in the bottom line. After all, El Al is a company with huge revenue - about $2 billion a year, so a major saving in expenses amounting to a big proportion of revenue should amount to a great deal of money. Indeed, El Al did make a bigger profit, but not really like it should have, and its profit this year shrank substantially, in effect wiping out the improvement that resulted from the fall in jet fuel prices.

The share price behaved accordingly - it rose with the fall in jet fuel prices (in expectation of a huge profit), and continually subsided in tandem with the airline's disappointing financial statements.

El Al might say that the main reason is competition, and it is true that competition is taking a toll, but when there is competition, companies streamline, lay off workers, and create additional sources of revenue. When there is competition, you think outside the box. El Al is limited in this - "a 'streamlining plan' is mentioned from time to time, but in practice, management makes noises and the company carries on as usual.

Accounting that takes the company's calculations into account

In conclusions, I promised more details about the value of the airliners, and how El Al leaves it higher than the fair value. In its reports, the company records the use value of the planes - this is the value for the company of using the air fleet. They take the projected cash flow - revenue according to the flight prices; expenses according to jet fuel prices, salary costs, etc.; get the profit and the cash flow from current activity; and discount it to the present. This is what the company regards as a calculation for obtaining the value of the planes.

This value, if it exceeds the cost in the books, "strengthens" it - it does not reduce the cost in the books, even though the fair value is low, because from an accounting standpoint, the test is against the value as seen by the company. This value is not gospel truth - it is a forecast. It can be toppled in a moment by an incorrect discounting rate, lower occupancy, increase in fuel costs, etc., etc. Still, the accounting is based on these numbers.

The author is a lecturer in accounting, financial statement analysis, and valuations, and a consultant in these areas. In any case, these reports should not be regarded as advice and/or a recommendation to buy or sell any security. Anyone whose actions are based on the article and/or on its content bears the exclusive responsibility for any damage and/or loss caused to him.

Published by Globes [online], Israel Business News - www.globes-online.com - on December 3, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

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