Parliamentary Portfolio Committee on Public Enterprises

1. 28 August 2012 Parliamentary Portfolio Committee on Public Enterprises Ensuring A Stable Future for SAA Despite Turbulent Times for World Airlines

2. SAA Presentation to Parliament’s Portfolio Committee on Public Enterprises Key Areas Today 1 Africa Expansion Programme 2 Airbus Procurement Hedging 3 Page 2

3. SAA’s Growth Strategy in Africa 1 African Strategic Context 2 African Network Performance Update 3 Strategic Challenges Facing SAA 4 SAA’s Strategic Response: Growth and Optimisation All data sourced from: IATA’s PaxIS; SAA RCT Report and the APG forecasting tool. Page 3

4. SAA’s African Reach • SAA has already achieved substantial African operational scale • We continue to plan for and open additional routes • SAA currently flies to 26 destinations on the continent • We serve 21 African countries outside South Africa • We carry an average of 4,600 passengers per day on these routes Page 4

5. Johannesburg Hub Strategy • Growing traffic to our continental destinations from outside Africa a strong indication our Johannesburg hub concept paying off • Increasing numbers of international passengers using Johannesburg as easy transit point from • Beijing • Sao Paulo • Buenos Aires • Mumbai • Perth • Hong Kong Page 5

6. Top Carriers serving Africa to Non-African Points • Capacity to and from Africa over past 2 years has increased by more than 32% • Mostly provided by non-African Ailines

7. Strategic Challenges to SAA • Emirates continues to grow its network in Africa • Emirates is able to grow in relation to SAA on an on-going basis • Their particular model of state ownership enables invisible subsidies, eg. through aircraft financing not available to others • Emirates have a simple growth with substantial fleet, network and product advantages over SAA • Their non-direct flight pricing is having long-term market behaviour consequences • Passenger network and monthly seat capacity • November 2006: • 16 destinations / 140,168 seats • June 2012 • 18 destinations / 462,790 seats • Flydubai: 5 destinations / 21,735 seats 23 African destinations Seats: 484,525 230% Increase in six years Page 7

8. Strategic Challenges to SAA • Other African Airlines continue to grow their networks in Africa • SAA is still the largest airline in Africa, measured by RPKs • Egypt Air carries 43% more passengers in a single airline group with regional jet operations. • Other African airlines continue to grow in relation to SAA • Some are expanding aggressively, seeking to emulate the Emirates model, including leveraging higher and mid-hemisphere positions • They are either fully or partly state owned and subsidised • Their expanding networks reduce the need to travel via Johannesburg and provide greater access to competing tourism markets • FY 06/07 vs. FY 12/13 Capacity: • These competitors add capacity and develop new routes very quickly • Their fleets have grown: Egypt Air has 72 passenger aircraft, Ethiopian 33 and growing fastest, Kenya Airways plans to double their fleet in five years from 32 now • SAA/Mango have together 53 passenger aircraft Page 8

9. SAA’s Response: A Growth and Optimisation Strategy • We have looked in detail at what successful airlines are doing • We are proposing for discussion among stakeholders a strategy to • build on our strengths • learn from our partners and peers internationally, including their successes and mistakes • meet our challengers with innovative, well reasoned responses • Our proposed growth and optimisation strategy includes • New route development or increased capacity from our Johannesburg hub • Replicating brand and operating hubs in new African markets, including Mango regional operations • Expanding the role and offering of our non-airline subsidiaries, such as SAA Technical and Air Chefs on the continent Page 9

10. SAA’s Response:Growth and Optimisation • New route development from Johannesburg hubs to African destinations where • traffic rights available • passenger volumes sufficient • SAA routes launched from Johannesburg FY 2011/12 • Ndola (Zambia) (October 2011) • Pointe Noire (Republic of Congo) (January 2012) • Bujumbura/Kigali (Burundi and Rwanda) (January 2012) • + additional capacity increases on some existing routes • SAA routes launched in FY 2012/13 • Johannesburg: • Cotonou (Benin) (May 2012) • Abidjan (Cote d’Ivoire) (August 2012) • Brazzaville (Republic of Congo) (September 2013) Page 10

11. SAA’s Response:Growth on Existing Routes • Further route development from Johannesburg hub • Some of these destinations present challenges regarding traffic rights • SAA has growth plans for some existing routes, including • Dar Es Salaam (Tanzania) • Lusaka (Zambia) • Harare (Zimbabwe) • Accra (Ghana ) • We are currently evaluating two or three more regional destinations for FY 13/14 Page 11

12. African Network Growth Faces Rights Challenges • In some core markets, SAA’s growth is limited by restrictions in bilateral air traffic agreements Mozambique • Restrictions on capacity or frequency • Recently revised to allow additional seats, we have applied • We will increases services as soon as bilateral approvals are granted DRC • SAA restricted to four weekly frequencies per week • We would like to operate six weekly frequencies • This would offer our passengers more choice and greater connectivity throughout our network Angola • SAA restricted to seven weekly frequencies per week • We need double daily services (14 frequencies per week) to meet demand and offer better connectivity to South America and the Far East Page 12

13. Strategic Exercise – Replicate Brands and Hub? • We are examining LAN Chile’s recent successes closely • To overcome their “end of hemisphere” disadvantage, they established branded hubs in other, more northerly parts of South America • LAN’s only hub in 2001 was Santiago • Over the next four years, they “climbed the hemisphere” with • strong Department of Transport support • a focus on weaker markets with no defending airlines • a very strong balance sheet • Today, LAN has investments in • LAN Chile (100%) • LAN Ecuador (45%) (founded 2002) • LAN Peru (70%) (2002) • LAN Dominicana (49%) (2003) • LAN Argentina (49%) (2005) • Currently, LAN is about to merge with Brazil’s TAM Page 13

14. Strategic Exercise – Replicate Brands and Hub? • We are examining Ethiopian’s new strategy closely • Ethiopian Airlines hub Addis Ababa has a strong, almost mid-hemisphere position • Ethiopian follows a long-term growth strategy of new route development • They have grown passenger numbers 79% and freight tonnage 117% • Freight now makes up 17% of revenue • Ethiopian is expanding its geographical advantage and reach by establishing Asky in Togo, taking a 25% equity stake • Ethiopian operates to 13 of 18 Asky West and Central African destinations, including the Asky hub in Lome • This maximises feed and de-feed to both networks and draws traffic through Ethiopian’s Addis Ababa hub to their long haul network • Subject to shareholder approval, our strategic exercise is to examine whether this east-west partnership could be a model for a north-south axis involving SAA and SAX Page 14

15. Strategic Exercise: A West African Hub? • We are looking at the feasability of a West African SAA/SAX/Mango hub • SAA and alliance partners would gain new hub in almost mid-hemisphere position • Could draw more traffic through Johannesburg • Our current ECOWAS air traffic analysis shows that • West Africa is substantially under-served • Ghana is the prime location for a potential joint venture • We are currently in discussion with the government on this possibility • Critical success factors currently under examination: • SAA would need to take a ≤49% equity stake • A sound local partner with capital • SA Express or Mango the preferred brand for market entry • SAA to increase SA-Ghana capacity for long haul feeder traffic, especially to South America, Asia, Australia • SAA subsidiaries Cargo, Technical and Air Chefs to provide skills and technology transfer to new airline and Ghana to ensure Ghanaian government support Page 15

16. Strategic Exercise: Expanding Mango into Regional Markets? • We are looking at the feasability of expanding Mango into regional leisure markets • Mango’s low cost base makes it a very competitive airline within Africa • We have completed a flight operational evaluation of all leisure destinations within B738 range of South Africa • These include • Mauritius • Zanzibar • Kilimanjaro • Mombassa • Livingstone • Mango received an International Air Services License in September 2011 • Start of Lanseria operations on 1 June provides additional operational and commercial opportunities Mango’s use as a regional market growth tool would support the Group’s growth objectives Page 16

17. Strategic Exercise: New Market Entry via SAA Subsidiaries? • We are looking at expanding subsidiaries into new markets as a possible • compliment to potential airline expansion • stand alone growth element • This growth strategy successfully implemented by Lufthansa and Singapore Airlines • SAA Cargo • Air cargo service are fundamental to African development • Cargo can be 20% of airline revenue, faces fewer bilateral restrictions • New route developments are planned by SAA Cargo • Air Chefs • Kenya a potential first market for our in-flight catering services • Lufthansa subsidiary LSG Skychefs already operating in many African markets, showing potetnial • SAA Technical • Initial support set-up and support for SAA /alliance partners start-ups in West Africa • Evaluating full function base facitlity by signing up maitenance agreements with local, regional and international carriers operating in and around West Africa • Plan would include scheduled/non-scheduled maintenance services and component/part logistics support Page 17

18. African Network Performance Update • Financial Overview, African Routes: • Financial Year To Date (April – July) 2010 vs 2011 vs 2012 Comments • In FY 11/12, SAA introduced services to Ndola, Pointe-Noire, Kigali, Bujumbura, and added capacity and frequency to profitable destinations in Africa such as HRE, LUN and MPM • Overall ASK offering has remained relatively stable, with slight year on year increases. • Increase in revenue paying passengers and load factor due to increased demand in FY 11/12 • SAA has also absorbed demand following demise of Air Zimbabwe, Zambezi Airlines, and Air Malawi Page 18

19. The Good News: We Are Growing in Africa 5 years ago... Currently… • SAA is the dominant carrier linking South Africa with the continent • We have grown this role in the last five years, our share continue to increase on regional markets Page 19

20. SAA Presentation to Portfolio Committee on Public Enterprises 1 Africa Expansion Programme 2 Airbus Procurement 3 Hedging Page 20

21. Airbus Procurement: Background • The initial contract was entered into with Airbus in 2002, for 15 aircraft • Contract renegotiated in 2008: • Price reductions • Five additional aircraft, bringing the order to 20 in total • Deferral of deliveries • Flexibility of choice between A320’s and A321’s • Deliveries between June 2013 and late 2017 Page 21

22. Airbus Procurement: Financing • Financial obligations of this transaction are onerous • Various alternative financing options are being considered with a view to • transferring the acquisition price obligations of the A320s to a financier • re-financing the Pre-Delivery Payments already made by SAA Page 22

23. Airbus Procurement: Engaging Potential Funders • Engaged with the three major European Export Credit Agencies, who provide credit services on many aircraft purchases • SAA consulted both local and international potential counter parties • We issued a Request for Proposals (RFP) on alternative financing possibilities • Responses received from a broad range of potential bidders • Responses to the RFP are currently being considered • Currently also engaging Airbus on potential alternative financing options Page 23

24. SAA Presentation to Portfolio Committee on Public Enterprises Contents 1 Africa Expansion Programme 2 Airbus Procurement 3 Hedging Page 24

25. What is Hedging? • Hedging is a method of reducing or protecting oneself from the risk of loss caused by price fluctuations in a specific market or commodity • Normally consists of taking positions which off-set each other • It’s a method that introduces some form of certainty in an uncertain market, in order to reduce risk • Protection normally achieved during periods of volatility • Hedging is a form of insurance to provide greater stability • But it cannot reduce fuel prices or stabilise exchange rates in the long-run Page 25

26. Advantages and Disadvantages of Hedging • Advantages: • Creates greater price certainty • Counters short-term volatility in the market • Limits losses • Disadvantages: • Can negate positive market movements • Can be extremely costly • Not possible or advisable to hedge 100% of exposure • Realisation of losses if stop loss limits exceeded (i.e. exposure beyond the limits of what is hedged against) Page 26

27. Major Risks Airlines Face • The most important risks exposures faced by airlines are: • Currency: • Rand weakness against major currencies affects SAA • For example, in the past year the Rand weakened by almost 20% against the US Dollar • Many costs are in Dollars or Euros (fuel, aircraft, spares) • Commodities: • Oil price rises affect all airlines • In the past financial year SAA’s fuel cost increased by R2.2 bn (36%) Page 27

28. SAA’s Hedging Philosophy • Reduce volatility of jet fuel costs and effect this has on SAA’s cash flow and earnings • contribute to price stability • Occupy a competitive position in the industry in terms of jet fuel price risk management • negate competitive advantage competitors derive from their jet fuel risk management strategies • Hedging at SAA specific and NOT of speculative nature • Provide a protection buffer during times of very high jet fuel prices Page 28

29. Review and Monitoring of Hedging • The Financial Risk Management Policy (including hedging policy) is reviewed annually and all stakeholders are consulted • The new hedging approach is supported by an analytical framework which allows SAA to measure the cash flow at risk from hedging • All hedge positions are monitored by the Financial and Risk Sub-committee and reported to the Executive Committee, the Audit Committee and the Board • Limits are monitored daily by the Treasury Back Office • All limits are reviewed quarterly Page 29

30. How do we Hedge? • The hedging policy includes • Currency hedging limits • hedging net currency exposure with a maximum of 75% of future exposures • Fuel hedging limits • hedging to a maximum of 60% of budgeted exposure • maximum of 12 months forward • Hedging tools: SAA uses the Oliver Wyman model • SAA considers ‘net exposures’ to determine value at risk, which means that natural hedges are also taken into account • Hedging instruments: Options, Swaps and Forwards Page 30

31. SAA’s Hedging Programme used Underlying exposure Duration of hedge Volumehedged Instruments used • Commodities • Jet fuel • Gas Oil • Crude • FX • USD • GBP • EUR • Current needs only • Less than 12 months • Greater than 12 months • Varied by underlying exposure • Adhere to policy • Adjust volume hedged according to market intelligence • Restructure hedges due to changes in exposure and / or risk appetite • Forwards • Swaps • Call options • Collars

32. Industry Best Practice • Common practice for all main line carriers to hedge to some degree: • Delta Airlines 40% hedged through to 2011 • Cathay Pacific 35% to 40% hedged in 2011 (50% in 2010) • Malaysia Airlines covered 33% in 2011 (60% 2010) • Lufthansa 85% hedged with a lead time of 24 months • SAA’s policy is conservative • The approved targeted range is as follows: • Fuel - minimum 0% and Max 60% - 12 month rolling • Foreign exchange – minimum 0% and maximum 75% of future exposure Page 32

33. Why Hedging Matters: Fuel as a % of total costs Fuel costs continue to escalate sharply as a % of total costs Page 35

34. Fuel Prices Affect Profitability • Fuel prices heavily influence SAA’s profitability • SAA’s profits are much higher when fuel is low • Hedging allows us to mitigate this effect Page 36

35. Hedging Lessons from the Past • More dynamic approach required towards managing risk exposure • Changing market conditionsrequire more than just taking a view without sufficient flexibility • The risk of imposing minimum hedge ratio limits – removes discretion to increase / decrease hedging ratios during times of volatility • Put more emphasis on the upside risk when reviewing market context • Simpler is better • Keep away from exotic hedging instruments. Page 39

36. SAA Presentation to Portfolio Committee on Public Enterprises Questions? Page 40