A Tale Of Two Profits

Virgin Blue’s underlying profit actually increased by 7. 6 per cent to $135 million.

This was on revenue of $1. 2 billion, which was up 8. 1 per cent on the previous half.

Qantas on the other hand reported a much stronger net profit of $618 million, with the profit before tax a staggering $905 million. This represents a massive 78 per cent increase on the previous year’s PBT, and was achieved on revenues of $8. 1 billion.

Qantas CEO Geoff Dixon pointed to the success of the carrier’s two brand strategy, saying, “We have two very strongly performing full service and leisure brands.

Our ability to direct our flying to the most appropriate markets is giving us a unique competitive advantage. ” The strength of the strategy was shown to good effect, with the Qantas posting an increase in passenger revenue of 4. 8 per cent to $5. 5 billion, largely driven by a yield increase of 4. 4 per cent. The combined Qantas brands (which also include QantasLink and Qantas Defence Services) reported a contribution of $830 million to the PBT result.

Jetstar performed very strongly, quadrupling its PBT for the half to $113 million.

This was despite a fall in yield of 5. 6 per cent. The strong result was attributed to strong demand in the leisure sector and the growth of Jetstar’s international services, which saw new services to Osaka and Kuala Lumpur start during the reporting period.

Qantas continues to enjoy a clear advantage in the premium sector which it has largely had to itself for a number of years, but Virgin is trying to move into this segment with a number of new initiatives as part of its new world carrier strategy.

One of these is the launch of its new premium economy product. This is seeing the first few rows of both the E-Jet and 737 reduced to a 2+2 configuration, albeit with the ability to convert these to regular economy seats when needed.

Passengers travelling in premium economy will also have the benefit of priority check-in, lounge access, and 12kg of extra baggage. Extra status credits for the Velocity Rewards program are also offered and the fares are fully flexible and refundable.

Another fruit of the change in strategy has been its increased cooperation with other carriers. At the profit announcement, Godfrey also announced that the airline had struck an interline agreement with Thai Airways. Hawaiian Airlines has also expanded its codeshare relationship with Virgin to now include flights from Sydney to Port Macquarie, Albury and Canberra.

While these initiatives are expected to have positive effects on the business and increase its long term yields, it has come at a short term cost.

The financial report for the half revealed that the carrier’s cost per available seat kilometre (CASK) increased by 5. 6 per cent to 8. 98 cents per ASK, well above its original costs when the airline started as a discount carrier in 2001.

This has now widened the cost gap between Virgin Blue and Jetstar, with Jetstar now 30 per cent cheaper on costs than its new world competitor, with CASK of 5. 16 cents.

Dixon took great delight in pointing out to media that the Qantas Group’s CASK is now below Virgin Blue’s, but he did not elaborate on what the Group CASK actually is.

As the product changes and costs push higher, Virgin will soon face the challenging decision of what to do about the budget segment. Godfrey reiterated the carrier’s threat to start an ultra low cost carrier to compete against Jetstar and Tiger, and recent reports seem to link in Air Asia as a possible partner in such a move (see ‘The Asian Armada’ article from p30 this issue).

Such a move though could be dependent on Sir Richard Branson’s interest in taking back control of the Australian carrier from Toll Holdings.

Toll has indicated that it will make a call on the future ofits shareholding in Virgin Blue this year. This could Toll selling down its stake in the carrier or even a full sale of its 62 per cent shareholding in the airline to Branson or another bidder.

Regardless of the ownership situation, Virgin Blue is also ploughing ahead with its plans to launch flights to the United States under its V Australia brand.

Announcements about the launch timing, routes and onboard product of V Australia were expected during March.

The airline was cleared to start a 10 times weekly service to the United States thanks to the new open skies agreement between the Australian and US governments signed on February 17.

The long term prospects of V Australia look strong, but it may take time and money to get the brand established before it turns a profit. Much of the carrier’s fortune also rests on how demand may be affected by any slowdown in the US economy.

Of course Qantas will not make it easy for the start of V Australia. The flying kangaroo announced that it will add an extra three flights per week to the United States, taking it to 51 return flights per week from Sydney, Melbourne and Brisbane.

With the entry of the A380 later this year, Qantas will continue to hold the most capacity on the US-Australia route. The new aircraft will also spearhead Qantas’s push to capture more of the premium market with an improved first and business class and an expanded premium economy cabin.

Qantas does also have the option of bringing Jetstar on the Pacific route once its larger 787-9s enter service.

But given the current delays with 787 this is unlikely to be an option for at least another three years.

Both airlines also used the profit announcements to update the market on changes they are making to individual businesses as they strive to build shareholder value.

Qantas management has demonstrated that it has learned a few things while talking with the would-havebeen private equity owners by announcing the merger of its Holidays and Business Travel divisions with Jetset Travelworld.

Under the merger, Qantas will hold 58 per cent of the vertically integrated travel company, which will remain ASX listed and retain the Jetset name. The transaction, which will only involve a transfer of shares, is expected to be finalised in April.

Qantas also signalled that it could be ready to spin off its Frequent Flyer business by the end of the year. The carrier is putting the finishing touches on what it calls an ‘enhanced redemption offering’. This is expected to effectively turn points into currency and make all seats available with varying redemption ‘prices’, and is expected to come online around mid-year.

Virgin has also announced that it is following the lead of Qantas and has engaged Goldman Sachs JB Were to advise the board on ways the carrier can extract more value.

Godfrey has said that this could involve its own spinoff of the Velocity Rewards program, but not until the program has matured.

The outlooks of the two companies were also starkly different. Godfrey warned that excess capacity in the Australian market would likely lead to a decline in yields and therefore profits for the second half of the year.

He added that launch costs relating to V Australia and the expansion of Pacific Blue on to regional routes in New Zealand could also drag down Virgin Blue’s bottom line.

Dixon, on the other hand, issued guidance that he expects the company to continue to perform strongly and predicted a rise in full year profit of ‘at least’ 40 per cent.

He shrugged off suggestions of a slowdown or overcapacity in the domestic Australian market, claiming that he did not see any reduction in demand in Australia, with the only weakness being in the UK and Japanese markets.

He also commented on Lateline Business on ABC TV that the airline was well placed to ride out any downturn due to the number of slide rights it had most of its aircraft on order. These will give it the flexibility to defer delivery of aircraft if needed. The airline also could choose to retire a number of aircraft currently in its fleet as many of these are fully depreciated or on operating lease.

The announcements of the profits, initiatives and outlooks of the two carriers both paint different pictures.

The year end results around August will show which picture is the truer representation of the market. o