Where to from here?

But this was quickly undone during the second half of the year, as the price of oil surged to new records, leaving those carriers without strong hedging positions in uncharted territory, and making the outlook much bleaker than expected.

Indications are of a softening in demand on leisure routes, which will hurt Virgin Blue and Jetstar. Further, both carriers face more competition from Tiger Airways on these markets, although the Singaporean owned airline has not made any comments about how it has been faring in the Australian market, apart from noting its strong load factors.

For Virgin Blue, the poor conditions in the second half saw it post a 54. 7 per cent drop in net profit to $98 million for the full year. The higher fuel burden, start-up costs for Pacific Blue’s New Zealand network late last year, and the addition of the Embraer E-Jet fleet from October last year dragged the result down.

“I think it’s fair to say that the second half of this financial year was particularly tough, and although market consensus had us coming in at a slight loss for the year, for the second half in particular, some small consolation was that we actually managed to turn a small profit, albeit nothing to write home about I assure you,” said Godfrey.

By comparison, Qantas announced on August 21 that it had lifted its net profit for the full year by over 40 per cent to $970 million, thanks to what CEO Geoff Dixon described conditions as the “sweetest spot we’ve ever seen in aviation,” during the first half of the financial year.

“I think it’s a very good result, and I think that it does emphasise the underlying strength of the company. This by any stretch of the imagination is a pretty good result,” said Dixon.

As a sign of the impact which the fuel prices and lower demand have had on Jetstar, and one of the advantages of the famous “two brand strategy,” Dixon attributed the strong performance to Qantas’s mainline flying businesses.

“Provided we can continue, and I’m quite sure we can, with making sure we’re efficient and we continue our investment in product and if you look at this result, the big driver, the really big driver of the success of this company is the Qantas mainline,” he said, adding that the Flying Kangaroo had “never been in better shape”, despite falling on-time

Geoff Dixon described conditions as the “sweetest spot we’ve ever seen in aviation,” during the first half of the financial year.

performance and recent media scrutiny of its maintenance standards.

Qantas-branded flying businesses contributed $935 million in profit before tax for the year, representing a 21. 6 per cent increase on the previous year, driven mostly by higher yields and load factors.

Jetstar’s flying businesses (including the consolidation of Qantas’s stakes in Jetstar Asia and Jetstar Pacific) reported a $115. 7 million PBT for the year on lower costs and higher passenger numbers, although yield fell.

The saviour for Qantas, apart from the strong conditions it enjoyed in late 2007, has been its prudent fuel hedging strategy, which saw all of its fuel for the year hedged at US$75 a barrel at a time when other carriers were paying more than twice that.

At the smaller end of the market, Regional Express posted a small rise in profit of three per cent to $24. 3 million for the year, and even managed to lift its profit by 32 per cent in the challenging fourth quarter.

Rex’s chairman Lim Kim Hai highlighted the result, saying, “Almost all the airlines we know of had huge declines in profits in the quarter.

Rex was completely un-hedged and we continued to show strong growth. ” Nevertheless, Rex did pare back its services during the year, but unlike Qantas, Jetstar and Virgin Blue, it was attributed to a shortage of pilots rather than slowing demand or fuel costs.

“Dropping some of those poorer performing routes that we were forced to do during the pilot shortage assisted our last quarter performance quite dramatically,” Rex’s GM of network, strategy and sales, Warrick Lodge, told the ABC.

Across the Tasman, Air New Zealand reported a 24 per cent drop in full year normalised earnings to NZ$197 million (A$161m). This was despite strong revenue growth, driven by strong performance on the airline’s long haul routes.

Fuel hit the Kiwi carrier hard. “While our hedging policy partly insulated us from the impact of crude oil price increases, refining margins over the second half added a significant cost to the business,” said CEO Rob Fyfe.

The double-digit capacity growth in the Australian domestic market during the year has also resulted in slowing demand, weakening yields for Jetstar, Virgin Blue and to a lesser extent Qantas, and forcing the airlines to ground aircraft and scale back their growth trajectories for the year ahead.

And despite more competition on some leisure routes from Tiger Airways and the threat of a recession, there are some indications that demand may only experience a short term dip rather than a fundamental contraction, and business may already be improving.

“The business, particularly at the leisure end is soft, although Jetstar had a tremendously good July but a poor May and June,” said Dixon, possibly signalling that demand may pick up over the year, albeit not in a record breaking way.

Nevertheless, both Qantas and Virgin Blue have hedged their bets on the domestic market by planning significant growth on international routes during the 2008/09 financial year.

For Virgin Blue, this means that its Pacific Blue subsidiary “will go exponential this year,” according to Godfrey.

The airline has moved four Boeing 737-800s from the Australian market over to its Christchurch based carrier, and has already announced plans to add more services on the Tasman, most notably from Auckland to Sydney and Melbourne.

However, it appears inevitable that the planned capacity growth by Pacific Blue, as well as the addition of the A380 by Emirates onto the Sydney-Auckland route in February, which together will add approximately 10 per cent capacity growth, will put significant pressure on Air New Zealand.

“It is certainly expected that we will see some yield decline on the Tasman,” said Fyfe, adding that the carrier has already taken the step of slashing its lead-in fares on trans-Tasman flights. For Virgin Blue, this means that its Pacific Blue subsidiary “will go exponential this year,” according to Godfrey. The other major project for Virgin Blue – and the source of one of its biggest costs during the next financial year – will be the start of services by V Australia from December 15, which Godfrey said was running on time, despite a delay in delivery of the airline’s first Boeing 777-300ER.

“The aeroplane was scheduled to be with us in the end of September and that will now be the end of October.

But again, that does not impact on our timeline for the 15th of December,” said Godfrey, adding that three 777s would arrive before the end of the year with a fourth to arrive in April and the fifth before October 2009.

Godfrey also said that the fourth 777 would be used to start service to an unnamed destination, while the fifth aircraft could be used to start services to South Africa. In August, the airline was awarded a five services a week designation on the route which it must utilise fully by October 2009.

But the launch of V Australia will also see Virgin Blue take a $50 million charge for the next financial year, and it expects to record an operating loss. “V Australia was going to be some 12-15-18 months at a maximum to breakeven, and that’s still the case,” said Godfrey.

Despite the new competition it will face from V Australia, Qantas’s Dixon identified the US route as one of the markets where it was seeing strength in the business, but he also acknowledged that demand on some Asian destinations, including Singapore and Hong Kong were showing signs of weakness.

Over a barrel

Although few have been game enough to call an end to the record run of oil, the price of crude oil has come off its record price in recent weeks, with the trading price below US$110 a barrel at the time of writing. While this could give some relief to the airlines, it seems that nobody expects fuel costs do go down, too far.

“The second half of the 2008 financial year marked the start of a period of substantial adjustment in the industry and 2009 looks set to bring more changes as we learn to live with higher jet fuel costs,” said Air New Zealand chairman John Palmer.

The outlook was much the same at Qantas, where Dixon believes that the higher cost of fuel will not allow it to record similar profits to those announced in August.

“The biggest determinant for this industry without a doubt is fuel and who would know where fuel would be in three years time,” said Dixon. “If there’s any justice in this world it will be down to about $30, but there’s no justice in this world so it won’t be I suppose. ” In an effort to address the “injustice” of high fuel prices, both Virgin Blue and Qantas have been busy building strong hedging positions. As of late August, Virgin Blue said it had 75 per cent of its fuel requirements for the year hedged at US$122 a barrel, while Qantas’s incoming CFO Colin Storrie reported that it had 81 per cent of its fuel hedged at US$118 a barrel.

Even with these protections in place, both airlines are expecting their fuel bills for the year to be significantly higher, with Virgin bracing for a $225 million increase in fuel costs while Qantas has indicated it is likely to pay $1 billion more this year for its fuel.

Despite fears that the higher costs would force the carriers to cut jobs, Qantas has been the only one to announce redundancies. Even then, the 1500 jobs to be cut will be from administrative and middle management positions, and it appears that the airline will not cut its technical crew numbers.

Virgin Blue’s Godfrey has also stated earlier this year that he does not expect to have to cut any jobs, albeit on the premise that fuel doesn’t leap further this year. Interestingly, despite the extra cost it adds to the New Zealand based carrier, a number of Virgin Blue pilots have been seconded to operate the two aircraft which are being redeployed with Pacific Blue, seemingly in a move to preserve the number of technical crew at the airline.

While fuel prices remain higher, the fleet replacement plans of carriers in the region will continue to play a big part in their quest to cut costs. The Qantas Group is likely to realise some efficiency gains as it introduces more fuel efficient Airbus A380s and Boeing 787s into the fleets of Qantas and Jetstar respectively. (The Qantas Group has been spending around $2 billion a year on new aircraft, which will increaseto $2-to-3 billion a year as the A380s and 787s come on stream. ) Air New Zealand will also gain in efficiencies from 2010 when the first of its Boeing 777-300ERs arrive to start replacing Boeing 747-400s, while the 767s will be replaced by 787-9s from 2012.

Change For Good?

The next year is due to see some major changes within the airlines, as new faces take on key posts, and new strategic directions are set to deal with what Dixon has said will be a “new world order” for the aviation industry.

Qantas will face some adjustment when Jetstar CEO Alan Joyce takes over as the Group’s CEO following the company’s annual general meeting in November.

Although Joyce earlier claimed that the only change between him and Dixon would be an Irish accent, the changes at Qantas have already started.

Qantas’s long running CFO and head of strategy Peter Gregg became the first of the senior management team to leave, announcing on August 20 that he was resigning effective September 31, to be succeeded by his deputy, Colin Storrie.

The fate of Qantas EGM John Borghetti appears to be firmer. “I’ve had quite a few conversations with John and I preface this to say that obviously in a situation in a change of a chief executive officer there are some disappointments and John, he’s just moving on with his life very well,” said Dixon. “John has indicated to me and he’s indicated to Alan that he is looking forward to working with Alan as we go forward. ” Nevertheless, Dixon also told reporters at the August 21 briefing, “The organisational structure will evolve over a period of time and then when Alan takes over as CEO I am quite sure that it will be put out and we will let you know then. ” One of the key challenges facing Joyce and his management team will be to rebuild the Qantas brand, which has been damaged by the QF30 incident and recent media and CASA scrutiny of the airline’s maintenance, safety and customer service standards.

However, Joyce believes that there has been no permanent damage to the Qantas brand. “This company’s got an amazing reputation internationally and in Australia, and … I think these issues we’ve seen them in the past and certainly they can have a short term impact on the perceptions but we don’t believe its long term. ” Over the medium term, it also seems that Joyce will be left to steer Qantas through a season of consolidation whichcould see it merge with another airline as has been long foreshadowed by Dixon, who has called for governments to show “maturity” in the debate on consolidation, and allow carriers to merge across borders.

“I think in coming years, Australians in general and the majority in Australia are really going to have to realise that as strong as Qantas is, and as big as it is, there will have to be some form of consolidation.

There will have to be some flexibilities, some compromises made to ensure that Qantas is part of whatever happens in this consolidation process,” said Dixon.

But Air New Zealand’s Fyfe claimed that his airline was not a natural target for consolidation, contrary to previous remarks by Dixon. “We do take a view that the world looks quite different for us, and our position as a standalone carrier is probably more sustainable and less in the sights of other larger global players than what Qantas is,” Fyfe said.

“That’s not to say that our position as an independent, for want of a better term, is sustainable indefinitely, but certainly we don’t see any pressure in the short to medium term,” he added.

Back across the Tasman Virgin Blue will also face changes at the top, thanks to Toll Holdings’s decision to sell down its stake, which was completed in late August. As a result, four Toll-appointed board members have stepped down, except for chairman Neil Chatfield, who will stay on until its AGM in November, at which time a new board will be voted on.

Overall, while the publicly listed airlines have had varied profits, the uncertainty over the price of fuel and a seemingly slowing Australian economy will certainly make it harder for the airlines to make profits. Nevertheless, with steps taken to lessen these impacts, it appears that to varying degrees all the local airlines are in robust health, which is good news for staff and shareholders alike.

Going out on a high note

Outgoing Qantas CEO Geoff Dixon was in fine form holding court at his last annual results press conference before he steps down in November. Always forthright, sometimes prickly, and mostly entertaining, here are a few choice quotes and comments from ‘Dicko’: “That is the greatest bit of nonsense I’ve heard. ” On a journalist’s assertion that sacked staff bear all the pain of tough market conditions while shareholders enjoy increased profit dividends.

“I think your statement is wrong. ” In response to the same journalist’s follow-up remarks.

“I think they felt I had the proverbial shit sandwich to tell you the truth. ” Reflecting on industry observers’ sentiments of the difficult role he faced when he took over from James Strong as CEO in March 2001.

“This time last year was almost the sweetest spot we’ve ever seen in aviation. ” Wistfully recalling the market conditions of 12 months ago.

“Well it’s not going to concern me too much after 30 November!” Joking in response to a question about Virgin Blue expecting a tough next three years.

“I’ve got 100 days to go and I’m counting them. . . ” Watching the clock until his November 28 retirement.

“I think I’ll pass on that. ” When asked if Qantas would be in better or worse condition had the failed APA private equity bid succeeded.

“We’re notorious tyre kickers. ” On looking into partnerships with other airlines.

“It must have been the shortest shortage of a professional group the world has ever seen. ” On the QantasLink pilot shortage, now eased due to high oil prices stopping dead airline capacity growth and hence the demand for new pilots.

“I’m not going to say that I will miss these in the future . . . but I’ve got to say I enjoy it. Thank you very much!” Geoff Dixon signs off.