Modest market return by ex-bankrupt Japan Airlines

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By Nathan Layne | September 19, 2012 6:35 PM EST

Less than three years after it collapsed into bankruptcy, Japan Airlines Co Ltd (JAL) <9201.T> made a modest market return on Wednesday, with its shares closing 1 percent above the price set for the world's second-biggest IPO of the year.

The $8.5 billion initial public offering had been priced conservatively to take account of the airline industry's tough outlook, with full-service carriers such as JAL under threat from low-cost operators in an already weak economy.

JAL's stock opened around 3 percent above the IPO price of 3,790 yen, but soon levelled off to close 1.1 percent higher at 3,830 yen - ranking it alongside Air China Ltd <601111.SS> as Asia's second-biggest airline by market value behind Singapore Airlines Ltd . Trading volume topped 40 million shares, worth around $2 billion.

Traders had suggested JAL, which emerged from bankruptcy with the highest level of operating profits in the industry, might climb as much as 10 percent on its market return given trading indications on the unofficial grey market.

CLSA Asia-Pacific Markets initiated coverage with a 'buy' rating on the stock, while Macquarie Capital Securities rated it 'outperform'. Both cited attractive valuations with a price-to-earnings ratio of about 5, around a third of the industry average. But both also noted the tough outlook for legacy, full-service airlines like JAL given increasing competition from budget carriers. Also, Japan's air travel market is mature and offers little prospect for volume growth.

"We find it difficult to recommend JAL or any other Japanese airline as a long-term fundamental investment," Macquarie analyst Nicholas Cunningham wrote in a client note. "In short, our recommendation comes down to a valuation call."

Brokers had warned that Japanese retail investors, who took up 70 percent of the IPO, might be quick to take profits given uncertainty over whether JAL's earnings may have already peaked.

"I'm not too bullish on JAL. Low-cost carriers have a larger market share now and competition is fiercer. It's unclear whether they can maintain their current level of profit," said Masato Futoi, head of cash equity trading at Tokai Tokyo Securities.

Budget airlines currently make up less than a tenth of the Japanese market but are expected to grow that to nearer 25 percent over the longer term. JAL is part-owner of JetStar Japan, a budget carrier run in partnership with Australia's Qantas Airways Ltd . JAL's biggest local rival All Nippon Airways <9202.T> has invested in two low-cost operators.

"Listing our stock is just the starting line for us as a private company," JAL President Yoshiharu Ueki told a briefing at the Tokyo Stock Exchange. "I'm not going to get caught up in where the stock is today. We will focus on boosting our corporate value through sound management and work to gain the trust of our shareholders."

BIG DEAL

Everything about JAL's fall and revival has been big.

The airline's IPO was second only this year to social networking giant Facebook Inc's $16 billion offering. Its $2.5 billion operating profit in the past business year was top-of-the-class for the industry, and its balance sheet, saddled with $25 billion in debts when it failed in January 2010, has been scrubbed clean.

The Enterprise Turnaround Initiative Corporation of Japan (ETIC), a state-backed fund that injected 350 billion yen into the carrier, sold its entire 96.5 percent stake in the IPO, generating around a $4 billion profit for national coffers.

Under ETIC's supervision, JAL took a knife to its bloated cost structure - shedding about a third of its workforce to around 31,000, slashing pension payouts and retiring its line-up of gas-guzzling jumbo jets.

JAL's cost per available seat kilometre (CASK) - a commonly used metric equal to the cost of maintaining a seat over the distance travelled - has dropped to 11.4 yen ($0.14) from 13.8 yen before bankruptcy. ANA's CASK is 12.9 yen.

JAL executives put the airline's swift revival down to the management system brought in by Chairman Emeritus Kazuo Inamori - in which individual business units are held accountable for maximizing profits, even those not directly generating revenue.

Under that system, unit leaders meet monthly to share cost-saving ideas and competitive intelligence, and are directed to put that information to work immediately, accelerating business decisions. Previously JAL's divisions operated in silos, with little thought given to trimming costs, executives have said.

CONTROVERSY, RISKS

While JAL estimates that three-quarters of its efficiency gains are due to job cuts and other structural reforms, its jump from industry basket-case to profit leader would not have been possible without massive state and private aid.

Banks forgave about 520 billion yen in debt. The write-down of its ageing fleet has put a huge dent in its depreciation expenses. Perhaps most significantly, it is sitting on 1.1 trillion yen in loss carryforwards, which could translate into a $4.5 billion corporate tax break stretched over nine years.

JAL has used its new-found financial muscle to order 45 Boeing 787 Dreamliners, a fuel-efficient jet positioned as crucial in its efforts to trim costs and increase seat capacity on international routes by 25 percent over five years.

ANA has cried foul, charging the tax breaks and other aid have created an unfair playing field. Behind the scenes it has lobbied for concessions, such as preferential allocation of landing slots coming due at Tokyo's Haneda airport around 2014.

($1 = 78.6100 Japanese yen) (Reporting by Nathan Layne, Dominic Lau and Sophie Knight; Editing by Ian Geoghegan)

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