MALAYSIAN AIRLINE SYSTEM BHD (MAS) and Brahim’s Holdings Bhd are unlikely to conclude the renegotiation of a catering contract by March 31 — the deadline to sign a new catering agreement (NCA) for the latter’s 70%-controlled unit, Brahim’s Airline Catering Sdn Bhd (BAC).

It is understood that one of the reasons for the delay is that MAS and Khazanah Nasional Bhd have yet to agree on the billing method for the in-flight meals. And the NCA is said to be for five years, which will cut short Brahim’s original 25-year contract, which would have expired in 2028.

According to a source familiar with the matter, both parties plan to extend the deadline by a month to end-April, which is provided for by a clause in a settlement agreement (SA).

“With the one-month extension, [the two parties] should be able to reach something by then,” says the source. However, it is unlikely that talks with Brahim’s will be aborted, given that MAS holds the remaining 30% stake in BAC.

Two billing methods are being discussed — budget and cost-plus, according to sources. Under the budget method, Brahim’s is given a fixed budget to cater a certain number of in-flight meals for MAS. Under the cost-plus model, which is currently used by the parties, Brahim’s supplies the meals based on its cost, plus an agreed profit margin.

The net profit margin range that is on the negotiation table is from 5% to 8%, according to another source.

Both methods have their pros and cons. For the budget billing method, Brahim’s may have more room to widen its profit margin with better cost management.  

From a volume perspective, sources say MAS currently requires about 40,000 meals a day, which Brahim’s is providing. Brahim’s kitchen at KLIA is said to have the capacity to supply about 60,000 meals a day.

When contacted, Khazanah, which wholly owns MAS and is overseeing the restructuring of the ailing national carrier, declined to comment.

The forced renegotiation of BAC’s 25-year contract appears to be a wake-up call for Brahim’s, which has taken a sudden interest in expanding its food and beverage (F&B) business to reduce its dependence on in-flight catering.

Last month, Brahim’s proposed acquisition of the Burger King franchise in Singapore and Malaysia from Ekuiti Nasional Bhd for RM95 million cash was shot down by its shareholders at an extraordinary general meeting by just a show of hands. The chairman did not request a poll.  

Interestingly, sources say Brahim’s has not given up its plan to acquire the fast-food chain.

Three weeks ago, Brahim’s shares were suspended from trading, pending a material announcement, at a time when the stock’s price was falling below RM1. The group then announced that it was in talks with a local F&B company, but it did not reveal the party or parties involved.

Nonetheless, Brahim’s does not have strong financial muscle to fund large acquisitions. The group’s net debt position has expanded from RM102.1 million to over RM134.9 million. Likewise, its net gearing has risen from 0.4 times to over 0.55 times. The bulk of the group’s term loans is secured against its equity interest in BAC.

Brahim’s cash flow is strangled because MAS is withholding payment to its catering unit. In addition, the airline is currently paying Brahim’s only 75% of what it did previously as a condition of the SA while the NCA is being finalised.

On top of that, MAS has cut unprofitable routes as part of its restructuring plan, thus affecting demand for in-flight meals served by Brahim’s. MAS’ contract used to contribute around 80% of Brahim’s earnings.

Brahim’s posted a net loss of RM40.3 million for the fourth quarter ended Dec 31, 2014, down from a net profit of RM12.68 million in the previous corresponding period. The loss was largely due to a write-down of RM56.08 million, from RM94.03 million owed to Brahim’s by MAS.

The write-down is part of the interim SA signed in October last year between MAS and Brahim’s where BAC agreed to take a 60% haircut on the money owed by MAS. The national carrier has already paid Brahim’s half of the outstanding sum of RM37.95 million. The balance will be settled once the NCA is signed.

Excluding the write-down, Brahim’s in-flight catering segment would have posted an estimated profit of RM14.64 million, a 39% drop from the previous year. At the same time, revenue fell 28% to RM76.46 million.

In other words, even with a 25% reduction in selling prices, Brahim’s in-flight catering business was still profitable. A source points out that the NCA would certainly not be the same sweetheart deal that earns margins of 20% or more. However, MAS is unlikely to give Brahim’s such a hard deal that the latter would have to struggle to survive.

The NCA will be a squeeze on Brahim’s earnings, but ultimately, it is still a profitable business for the group.

Despite the poor fourth-quarter results, Hong Leong Investment Bank Research has a “hold” recommendation on Brahim’s, with a target price of RM1.43.

Moving forward, investors would have to change their perception of Brahim’s, which was previously seen as an in-flight catering concessionaire given its long-term contract with the national carrier.

Whether Brahim’s share price would demand a premium, as it did before, will depend on how the company manages costs while maintaining meal quality.

This article first appeared in The Edge Malaysia Weekly, on March 30 - April 5, 2015.

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