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© Roberto Maggioni

Korean Air Lines, Hanjin Shipping’s largest shareholder, has provided little help to its subsidiary since bankruptcy emerged as the most likely outcome for the troubled carrier, deciding to commit and loan only $54m to the cause. How so?

On the one hand, its latest aborted round of financing and balance sheet show why clients of Hanjin – now forced to sell its Asia-US route network to pay creditors – should not count on any additional support from the flagship airline, which, arguably, has its own problems.

On the other, yield-starved investors are increasingly wary of contagion when it comes to borrowers that could ‘hide’ funds within complex corporate structures.

Cheap funding sought

Korean Air Lines (KAL) was recently on the verge of launching a 30-year, US-denominated hybrid bond package, which would have been used for “general corporate purposes”, had it not been cancelled.

In the debt capital markets (DCMs), when proceeds are budgeted for general corporate purposes, in most cases “they can seldom be tracked down by the lenders”, a senior loan banker in London reminded me this week.

“With plain-vanilla bonds and DCMs more broadly, it’s not much different, as you know.”

Lenders these days are cautious when lending to companies whose investment-grade rating may look solid on paper but has been under pressure for some time. Unsurprisingly, KAL’s debt deal was reportedly postponed.

What this means is simple: there was no way the borrower would raise the amount being sought, and it will unlikely make a comeback anytime soon by offering a similar financial instrument targeting the same investor base. That is usually how it works in DCMs when deals are “postponed”.

Market reports recently indicated that investors had demanded higher returns than the 7% all-in required by the borrower in order to commit to a new $300m debt financing. One caveat is that last year KAL borrowed $300m in a secured deal backed by the Export-Import Bank of Korea, but in 2014 it was reportedly a subsidiary in the driving seat when it borrowed $300m in a debut deal.

What could happen now to any fresh funds lent to KAL is not a small detail any more, given the Hanjin crisis, so it is relatively easy to speculate that accountability, or lack thereof, might have played a key role against the airline.

In fact, I understand that lenders also wanted to be rewarded for the risk in the case that KAL devoted at least past of those funds to help its container shipping subsidiary, whose global exposure is unknown as yet, but runs in the order of billions of dollars rather than millions. Its list of creditors, released this week, runs to 108 pages and lists more than 3,000 companies.

Feeling the pinch

Inevitably, KAL is feeling the pinch, and it is not exactly in a sweet spot financially, based on the latest financials for the first half of 2016, with total short- and long-term borrowings at about $6.5bn, excluding finance lease obligations.

Yet the sum of these two groups of liabilities brings the total at over 1x trailing revenues of $9.8bn – such a debt burden could become problematic if its core passenger business doesn’t deliver over the next few quarters and if lenders do not agree to meet its funding requests on convenient terms.

 Chart 1 KAL cost of debt

Korean Air LInes

The table shows how much the group is paying on some of its outstanding debt obligations, while the chart below indicates how its debts are split.

Chart 2 KAL debt (“borrowings’)

Korean Air Lines

Net leverage, as gauged by net debt divided by adjusted operating cash flows, amounts to over five times, and although a low-rate environment indicates funding alternatives could be sought, high indebtedness relative to cash flows prevented KAL from bailing out Hanjin.

On the bright side, however, at least in the short term, it could be argued that Hanjin’s demise could bring more business to KAL’s cargo unit, whose performance is shown in the table below. In the second quarter, cargo operations amounted to 21.5% of KRW2.7 trillion revenues, down 150 basis points as a percentage of group revenues year-on-year, so it could do with rising volumes and traffic.

Chart 3 Cargo

Korean Air LInes

Aside from that, the good news is that its core passenger unit is performing relatively well.

Chart KAL passenger

Korean Air Lines

 

But there are bigger interests at stake, and the failure of its recent funding round goes to the heart of the sustainability issue for Chaebols in South Korea; structural changes are long overdue at a time when the country’s supply chain lives one of its worst times ever, as Samsung’s latest Galaxy Note 7 fiasco also proves.

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