Under Pressure?

First to sniff a change in the wind was investment giant Merrill Lynch, which issued a “sell” recommendation on Qantas starting a sell-off in the airline’s shares – ahead of the plummet in value of the Australian and global sharemarkets.

In a mid January note to its clients, Merrill Lynch said the airline’s earnings and returns were expected to peak through 2008 due to a combination of factors including increased competition, a likely increase in ticket prices through the high price of fuel, and union demands.

Opening up Australia’s skies had set up a competitive landscape that will severely challenge the bottom lines of many airlines.

While still upbeat on the fiscal 2007-08 year of 40 per cent earnings growth to $1. 4 billion before tax, the investment house warned of a 20 per cent decline in profit for Qantas for 2008-09.

A day later Goldman Sachs JBWere dropped the airline from its list of companies with the strongest returns, although it didn’t agree that clients should sell.

In a client note analyst Alastair Hunter said that Qantas remained strong at least in the short term as it prepared for a sell-off of some parts of the business such as the Frequent Flyer program.

And the year hasn’t started all that well for Qantas, with the electrical fault on its 747 into Bangkok, union threats over pay claims that threatened to ground the airline, more coverage of the cargo fixing scandal, and a lifting of the fuel surcharge.

But those problems may be the least of its troubles as AirAsia is rumoured to be interested in a stake in Virgin Blue – a potentially killer combination according to the Sydney based Centre for Asia Pacific Aviation (CAPA).

According to CAPA chairman Peter Harbison, “rumours that AirAsia might buy into Virgin Blue raise an intriguing scenario, just as European and American airlines are exciting themselves with the prospect of mergers and acquisitions in their own markets. ” He added that “AirAsia’s statement to the Malaysian Borso (sharemarket) yesterday fell somewhat short of an outright dismissal of the possibility. ” It read “AirAsia Berhad, having made due and diligent enquiry, wishes to state that AirAsia has no knowledge of the contents of the (media report) as quoted. ” Australian Aviation also contacted AirAsia CEO Tony Fernandes who said he could not comment “at this time. ” With Virgin Blue majority owner Toll Holdings – with 62 per cent of the equity – making it clear it wishes to sell down its holding, a variety of scenarios may unfold during 2008, although the credit crunch and high fuel costs will certainly put paid to any Aviation Partners Australia styled private equity deal.

Possibly waiting in the wings to assist is the Virgin Group, and Harbison notes that “despite liquidating its majority holding in Virgin Blue at a tidy profit, Virgin Group remains very interested in the Australian market [with 25 per cent of Virgin Blue]; Virgin Atlantic flies to Sydney, via Hong Kong, from London; it operates from the UK to the US West Coast and could easily link with this year’s startup V Australia, when that Virgin Blue subsidiary commences 777 services across the Pacific in the fourth quarter. ” Harbison says all the pieces fit. “Well cashed up and already partnered with Sir Richard Branson’s Virgin Group in the Malaysian LCC’s long haul offshoot, AirAsia X, a music entrepreneur Tony Fernandes-led AirAsia would be an obvious target. And AirAsia has put its money where Australia is, by making its first route with AirAsia X an Australian one, from Gold Coast Airport to Kuala Lumpur.

And Tony and Sir Richard see eye to eye, strategically, if not physically. ” But while the fit may have looked good going into December 2007, January’s sharemarket slide will certainly take the gloss off any airline deal.

And the mood in the industry is cooling with Airbus and Boeing predicting softer order books in 2008 while Qantas, Jetstar, Tiger, Virgin and AirAsia all have large numbers of aircraft to be delivered this year with an overall lift of 10 per cent in capacity.

Most analysts see the credit crunch and fuel prices softening consumer demand while the global effect of the US economy is yet to be tested. Traditionally any slowdown in the US has had significant flow-on effects, although

The traditional warning signs of a slackening of cargo and premium travel demand were well and truly to the fore.

other countries’ economies are far more robust in the 21st century.

However, the traditional warning signs of a slackening of cargo and premium travel demand were well and truly to the fore at the close of 2007.

Growth in premium travel in Asia Pacific was down from 6. 6 per cent in September 2007 to just 1. 6 per cent in October 2007 over the same months in 2006, according to CAPA.

Harbison is also nervous about the Australian economy, saying that while many talk up the economy and its resilience, “my personal feeling is that it’s a bit more fragile than it appears. ” It is into this environment that an almost unprecedented expansion in domestic airline capacity, competitors and product developments is taking place.

One of those developments is Virgin Blue rolling out its new premium economy seat from April. The first three rows of its 737s will feature the red leather Recaro seats and the E-Jets will also sport the new product.

The introduction of a domestic premium product is a key component of the airline’s very successful ‘new world carrier’ strategy which is catering for business travellers. That focus is paying big dividends and in 2006-07 the airline posted a 92 per cent lift in net profit to $216 million, thanks to a 16. 3 per cent lift in revenue on just a 2. 9 per cent increase in production.

The launch of the seat – set at 34in (86cm) or more – is expected to undermine Qantas’s sole grip on the premium market.

Virgin is also taking delivery of more Embraer 170/190s with Canberra-Sydney ‘Capital Jet’ services due to have been launched on February 4 with 108 services a week.

Virgin Blue launched the services with a $99 fare and Qantas later dropped its cheapest fare on its 25 daily flights to $83. Qantas has also ordered more Q400s to be able to offer 737/Q400 only flights on its 325 weekly Sydney- Canberra flights.

On November 4 last year Virgin Blue also inked an important strategic interline partnership with Abu Dhabi based Eithad Airways that provides seamless connectivity to 22 Australian cities and from Brisbane and Sydney to Abu Dhabi and Eithad’s 45 international destinations. The deal came into effect immediately.

Etihad launched its daily service from Abu Dhabi to Sydney in March 2007, which was followed in September by the opening of its three flights a week service to Brisbane. From March Etihad’s Sydney service will go to 11 flights a week.

Another dynamic is Jetstar’s plans to open bases in Perth and Darwin with A320s to facilitate an expansion of its network, both domestically and internationally.

Jetstar’s operation out of Tullamarine is to be ramped up significantly with the 213-seat A321 to be deployed from March 18 on its Cairns and Gold Coast services, while the services to Hobart and the Sunshine Coast are to be bumped up to 200 flights a week.

The A321s are part of a Qantas Group order announced in November for up to 188 737s and A320s. The Jetstar component was for 68 A320 family aircraft including 17 A321s plus options.

While some of these assets are destined for Jetstar’s Asian affiliates the order represents a massive increase in capacity for Jetstar, which was also due to receive three A320s from Jetstar Asia by the end of January.

The aircraft influx will also support Jetstar’s Trans Tasman and domestic New Zealand ambitions along with short-haul international routes into Asia.

Joyce is not concerned about the size of Jetstar’s commitment, telling Australian Aviation: “We will have a portfolio of markets to absorb the aircraft. ” Joyce also adds that the extra capacity is “also about bringing travellers from Asia to Australia – not necessarily about domestic Australian services. ”Tiger Airways, which began domestic services in November, is also planning an additional base in Australia as it ponders its expansion plans. In all Tiger has 70 A320s on order for its operations based in Singapore, Seoul and Melbourne.

And just when airline executives thought the market couldn’t get any more crowded came the announcement that Indonesian low fare airline Lion Air, which has 122 215-seat 737-900ERs on order, was to enter a joint venture with Brisbane charter operator SkyAirWorld.

The airline, to be called Lion Air Australia, plans to start Australian operations later this year using six aircraft. Initially the airline will focus on services from Indonesia to Australia but the door is well and truly open to domestic Australian and other international services.

However, Lion Air Australia will test CASA regulatory oversight with Indonesian airlines banned from the EU on safety concerns. According to insiders there are many in CASA who are not happy with Garuda flying into Australia but they are bowing to political pressure from Canberra.

However, SkyAirWorld does have some depth in its operations department, such as its new head of flight operations, Rick Howell, who joined after seven years with Emirates. Nonetheless, Lion Air has suffered four crashes in the last five years – not exactly the scorecard CASA is looking for, and no doubt this will invite much scrutiny.

But despite the competitive challenges it faces, 2008 will be a big year for Qantas with massive publicity surrounding the arrival of the first A380 in mid August, with services due to start in September/October to Los Angeles.

At around the same time CAPA’s Harbison suggests that Qantas’s restructuring plans will be crystallised.

“Qantas’s big focus in 2008 will be on restructuring,” Harbison says. He maintains that Qantas will try to lock in the value of its massive order book for A380s, A330s, A320s, 787s and 737s, while the value is still high “and the best way to do that is to push that over to a separate company and then to lease them to Qantas at healthy rates. ” Taking some gloss off the launch of the A380 will be V Australia’s new fleet of 777-300ERs, to be delivered in the last quarter of 2008 for 10 weekly flights between the east coast of Australia and the US west coast.

In resource rich WA the state is booming on the back of long term commitments to ramp up production of a host of minerals. That boom has had an enormous impact on regional airlines in Western Australia.

Skywest, which only two years ago had three under-utilised 100-seat Fokker 100s operating just five hours a day, will take delivery of its sixth and seventh Fokker 100s in coming weeks and all are almost fully committed to regular publictransport or resource industry fly-in/flyout contracts. The airline has also added two more 46-seat Fokker 50s for a fleet total of seven.

Alliance Airlines, meanwhile, which has established a base in Perth, has snared a daily Perth-Karratha and Perth- Port Hedland service with a Fokker 100 for QantasLink. This aircraft – to be painted in QantasLink colours – will be in addition to the two Fokker 100s Alliance has in Perth for resource industry contract work.

The Qantas Group currently operates 19 return services per week between Perth and Port Hedland and 35 return services a week between Perth and Karratha, using 737s and 717s.

The decision appears to be a blow to National Jet Systems (NJS), which operates 11 Boeing 717s for QantasLink and was negotiating with Qantas to bring another online.

But Qantas general manager for regional airlines Narendra Kumar rejected any suggestion the Alliance decision reflected any deterioration of the relationship, saying that the airline “retains a strong and growing relationship with NJS. ” NJS has spare BAe 146 capacity but QantasLink has turned its back on the type after operating a sizeable fleet with NJS throughout the 1990s. This situation poses a dilemma for NJS, which is faced with increased competition from the more modern Fokker 100 fleets of Alliance and Skywest and Virgin Blue’s Embraer jets. Rumours would seem to indicate that NJS may be looking at a move to 737s – which Qantas will not endorse.

Until recently the four-engine BAe 146 had a significant advantage over other jets for many fly-in/fly-out contracts because of its performance into many of the typically shorter mine-site runways. However, a number of key resource companies are extending runways to accommodate larger jets such as the Boeing 737-800 and Airbus A320, thus negating the BAe 146’s advantage.

Enhancing Skywest’s position, Virgin Blue signed a strategic codeshare agreement with the airline in January which gives Virgin Blue’s passengers seamless access to a network that will now include Port Hedland, Kalgoorlie and Kununurra, while providing additional flights between Perth and Broome. Similarly, Skywest passengers can book through-flights onto the Virgin Blue network.

The codesharing alliance between Skywest and Virgin Blue probably means that Virgin won’t deploy its E-Jets in the West, which is not a surprise as Skywest managing director Hugh Davin had previously rejected the E-Jets – when chief of NJS in the West – as being unsuitable out of many northwest ports.

Across the Tasman Air New Zealand, which just picked up Air Transport World’s prestigious Passenger Service award, is planning a host of further passenger related enhancements, including the roll-out of a new short haul product, which promises to be world’s ultimate short haul domestic service.

Air New Zealand’s latest innovation centres on “removing as much hassle from domestic flights as possible,” says Bruce Parton, GM domestic airline.

The project, which will cost almost $20 million, involves a host of innovations – some unique – including valet parking, RFID (Radio Frequency ID) name tags for baggage, 35in (89cm) seat pitch for premium passengers, online check-in, boarding passes on mobile phones, free meal and drink service at appropriate times through the day, and 40 per cent larger lounges nationwide.

Parton tells Australian Aviation that the airline believes it can shorten the travel journey by 40 per cent by minimising the airport experience which, for most, is a real hassle. “Business travellers especially are always in control, except when it comes to airports and all travellers hate queues,” he notes. “Our mantras are ‘no queues’ and putting ‘the customer back in control’. ” With valet parking and RFID name tags, “premium customers simply drop the car curbside and their bag onto a moving belt and the airline does the rest,” says Parton. The RFID name tag is scanned and the airline’s computer system knows where the particular customer is travelling.

Parton says Air New Zealand started with a clean sheet for the domestic operation makeover. “Too oftendomestic services are just scaled-back international products and they are both very different styles of operation. ” The new domestic offering will be available at all Air New Zealand domestic airports. All 16 domestic Boeing 737-300s will be reconfigured over 18 months with the airline stripping out surplus galleys and one toilet to gain the extra legroom required. Twenty four seats will have a 35in (89cm) seat pitch, 40 will be set at 33in (84cm) and the balance evenly split between 31 and 30 in (79 and 76cm).

Qantas responded to the Air New Zealand lead by announcing that it would extend its popular Australian domestic Cityflyer product into the New Zealand domestic market.

Cityflyer provides passengers free beer and wine from 4pm (noon in Australia), free newspapers and an enhanced food offering. Qantas also announced the addition of online checkin, QuickCheck self-serve kiosks and a $3 million upgrade to its lounges in Auckland, Christchurch and Wellington.

And late last year the first Pacific Blue domestic flights took off linking Christchurch, Auckland and Wellington. The move into the domestic market follows four years operating across the Tasman. The airline is only linking Christchurch, Wellington and Auckland at this stage and there is some suggestion that its parent’s E-Jets will find their way onto internal New Zealand routes.

Air New Zealand’s fleet plans are modest this year with two more 737‑300s being added to expand jet presence in regional areas.

Not modest are the discounts – to today’s prices – which Air New Zealand secured when it obtained 42 purchase rights against an order for just eight 777s and two 787s in June 2004, at the bottom of the order cycle. Forgotten by many is the fact that Air New Zealand was the second customer for the 787 and the launch customer for the -9 model.

Air New Zealand took up a number of those price rights last year with an order for four Boeing 777‑300ERs with three options for delivery from 2010.

Air New Zealand CEO Rob Fyfe told Australian Aviation that, “showing great confidence in the future of the airline when the aircraft purchasing market was at the bottom of the cycle three years ago has really paid off. ” According to Fyfe when the airline has “taken delivery of all the aircraft we have on order, Air New Zealand will have one of the youngest, most technologically advanced, most fuel efficient and most environmentally friendly long haul fleets in the world. Simply, we will set a high benchmark and standard for all our competitors both in terms of operational efficiency and world class products and service. ” The 777-300ER purchase and the eight 787-9s the airline has on order will see the retirement of its 767s and 747-400s by 2012 and an expansion of services with direct links to India, South America and more services to China and North America.

In the interim Air New Zealand is rolling out a make-over of its A320s and 767s featuring individual on-demand video players and configuration changes for greater seat pitch for frequent fliers which the airline claims will be the best seat pitch – 35in/89cm – across the Tasman.

And while airlines in Australia and New Zealand argue they are the low fare champions, that title goes to Air New Zealand hands down with its ‘grab a seat’ website which has taken New Zealand by storm with daily specials.

The number of one-way seats sold since ‘grab a seat’ (GAS) was launched, around 17 months ago, is in excess of 170,000. Almost 14,000 of these have been on the international network with fares as low as NZ$399 to LAX return.

Domestic GAS fares generally range between NZ$1- $39.

Undoubtedly the strong profit growth airlines experienced in the last few years is leading to new product developments, competitive alignments and the arrival of new players on the local scene. But with new aircraft capacity and product developments being introduced just as the world’s economic skies appear to be clouding over, the challenges of running an airline in 2008 and beyond will be just as great as ever. At least airline managers can bank on the constant of continual change.