Differing fortunes

“The first half of the year was characterised by a generally favourable operating environment and strong demand,” said Qantas CEO Alan Joyce. “During the second half of the year, the environment deteriorated, with domestic and international competitor capacity continuing to grow and demand in key markets softening quickly as the global slowdown hit.”

The brunt of that change in conditions was felt by the Qantas brands, which recorded underlying earnings before interest and tax (EBIT) of $4 million for the year. Reading between the lines, that result means that the Qantas brand effectively lost nearly $200 million during the second half of the year, particularly as yield and passenger numbers on its international services plummeted.

The Australian domestic market has once again shown its ability to hedge the airlines from the poor international conditions.

“Qantas international business is losing money. Qantas domestic is making money and QantasLink is still making money,” Joyce said in an interview with ABC TV’s Inside Business program.

On the other side though, Qantas again showed the advantage of its two brand strategy, with Jetstar recording underlying earnings before interest and tax (EBIT) of $107 million, an increase of 4.9 per cent on the previous year. The budget carrier saw its passenger revenue rise by 14.6 per cent, driven by a rise in capacity of 14.4 per cent as it increased its international network. It was also aided by the inclusion of consolidated financials from Jetstar Asia for the first time following the restructuring of Qantas’s stake in the Singaporean airline.

The other boost to Qantas came from Frequent Flyer, which recorded underlying EBIT of $226 million. Joyce stated that the proposed IPO of the Frequent Flyer business has definitely been taken off the table. “Given the strategic value of Qantas Frequent Flyer to the Group, we will be retaining full ownership for the foreseeable future,” he said.

The Qantas result was followed one week later by the announcement of a net loss of $160 million by Virgin Blue, although any shock to this figure was lessened by the guidance given by the airline in July at the time it launched its $231.4 million capital raising.

“While airlines have been variously impacted by the global economic crisis, our approach was to respond swiftly and definitively to softening domestic demand,” said CEO Brett Godfrey. This primarily saw a move of capacity from domestic operations onto the Tasman and into Indonesia through its Pacific Blue subsidiary.

Those moves to redeploy capacity saw Virgin Blue’s domestic operations make an underlying EBIT of $57 million. Somewhat surprisingly, despite the 14.1 per cent increase in capacity, yield was down by only 2.4 per cent, which the company attributed to the ‘flight to value’ as business travellers sought out lower airfares.

For its part, V Australia recorded an underlying EBIT after foreign exchange and startup costs of $124 million on revenue of $69 million. Load factor was satisfactory at 62.3 per cent.

Across the Tasman, Air New Zealand performed impressively, recording normalised earnings of NZ$118m (A$95.4m), which was 19 per cent lower than the previous year. “The result positions Air New Zealand as one of the top airline performers globally but it falls short of delivering shareholders an appropriate commercial return,” said chairman John Palmer.

While overall passenger numbers at the Kiwi carrier were down 6.2 per cent, yield increased by 6.2 per cent to 13.8c/RPK as the carrier cut capacity by 7.2 per cent to counteract the fall in passenger demand. Interestingly, despite Virgin Blue shifting more capacity onto trans-Tasman flying through its Pacific Blue subsidiary, Air NZ managed to increase its shorthaul yields by 0.5 per cent.

While the profit figures were lower, the performance was standout against a global tide of red ink which has hit the industry. IATA is holding to its prediction of a global industry loss of US$9bn, driven primarily by carriers in the Asia-Pacific region.

For all three carriers, capacity cuts appear to have been a saving grace for the airlines, with all three announcing cuts, although Qantas and Virgin Blue’s cuts were more focused on the domestic market, while Air New Zealand has trimmed trans-Tasman capacity and made a number of tactical changes to its longhaul services.

Similarly, all three carriers took a number of measures to reduce their costs, including making staff redundancies, offering unpaid leave or moving to further part-time work.

Domestic shifts?

While Virgin Blue and Qantas have cut capacity– largely by reducing frequencies on some routes – the Australian domestic market has once again shown its ability to hedge the airlines from the poor international conditions.

Overall, data from the Bureau of Infrastructure, Transport and Regional Economics over the past financial year shows that domestic traffic still managed to record an increase of two per cent over the previous 12 months.

However, that increase in traffic appears to have been driven by the low cost carriers as passengers of all demographics have sought out value during the uncertain economic down times rather than the perks of business class.

As such, it came as little surprise that Joyce used the occasion of the results announcement to also announce that Jetstar would start flights between Sydney and Melbourne’s Tullamarine airport four times a day (see related article). Although primarily aimed at competing with Tiger Airways’ up to nine services per day on the route, the move is also aimed at helping to stem the loss of patronage from Qantas travellers.

Effectively, with Jetstar’s existing Sydney-Brisbane services, come October 25 Qantas and Jetstar will be flying side-by-side on two sides of the ‘golden triangle’. Potentially, this could signal a shift within the Qantas Group away from keeping the brands flying on different routes to using both to tackle different consumer segments.

Despite the current gravitation towards low cost carriers, Joyce also showed that there is still life in the full service model domestically, and that Qantas will put its focus on marketing more to small and medium enterprises over the next year, to take advantage of “untapped potential” in that segment.

“You know, when you look at how strong we are in the corporate market there aren’t the growth opportunities there… Despite the issues we had last year with on-time performance as a result of the industrial dispute, we didn’t lose a single corporate account, which shows that Qantas is the best for business,” said Joyce. “That’s why we believe there is an opportunity in the SME market for us to take share in that market and to grow a position, because we think we have all the components necessary to do that.”

While Qantas does have the product advantages and marketing in place, it seems that this will just bring it into greater competition with Virgin Blue, which has seen this as a core market under its New World Carrier strategy. As such, it may be an interesting test of whether Qantas can out-market Virgin Blue.

Longhaul sufferings

While it has long been considered a goldmine route, the entry of new competition and the resulting four-way fare war on the trans-Pacific route has been a major source of pain for Qantas and Virgin Blue, although less so for Air New Zealand.

With the additional capacity coming at a time when business class bookings have slumped, it has been something of a ‘perfect storm’ for the carriers on the route. Joyce told Inside Business that its key longhaul markets of London and Los Angeles were now generating losses, with premium traffic down by between 20-30 per cent on these routes.

Virgin Blue has decided to move all its longhaul eggs from the Pacific basket, with V Australia committed to launching services from Brisbane and Melbourne to Phuket and Melbourne to Johannesburg from next year. The carrier also plans to take over Pacific Blue’s services from Sydney to Nadi, although that decision was driven primarily by a need to increase the utilisation of its Boeing 777-300ER fleet.

Nevertheless, the Pacific market may be improving for V Australia, with the carrier reporting that loads during July were higher with similarly strong forward bookings, while customer acceptance of the carrier’s product has been very positive.

Help will also come if Virgin Blue and Delta Air Lines gain approval for their proposed joint venture, which would effectively allow them to merge their Pacific services. While the proposal has raised objections from Air New Zealand and Tiger Airways, incumbent carriers United Airlines and Qantas have not raised any objections, possibly signalling that it may help to bring some rationality back into pricing and yields on the route.

Despite the new competition from V Australia and Delta on the Pacific, Qantas has no plans to cede its US services to Jetstar any time soon. “To make money on LA and London, our firm belief is you need a mixture of business and leisure,” Joyce said. “You can’t actually specialise just at one end. So we don’t think that these are markets for Jetstar – they’re absolutely not markets for Jetstar – they’re real Qantas core markets.”

Nevertheless, Qantas did also announce that it plans to lease an additional four (with an option for a fifth) A330-200s to allow Jetstar to continue to roll out its low-cost longhaul network ahead of the delivery of its first Boeing 787-9s in 2013. That expansion is likely to continue to focus on Asia, particularly as the airline tries to catch up with AirAsia X’s increasing Australian footprint.

Joyce noted that there has been strong acceptance of the longhaul Jetstar product, even on the traditionally tough Japanese market. “The Japanese operation has seen a significant turnaround with profits now being generated on those routes, even despite the impact of H1N1,” said Joyce, who also added that there were no plans to replace the remaining Qantas services from Perth and Sydney to Tokyo.

Interestingly, Jetstar CEO Bruce Buchanan told The Australian newspaper in late August that the four new A330s which were leased could be used to launch one-stop services to southern Europe due to improvements in range on the later build aircraft.

Qantas and Air New Zealand are also making major adjustments to their international fleets. Qantas has already taken writedowns on five Boeing 767-300s and five 747-400s which will be sold, while Air New Zealand has started planning for the delivery of its first Boeing 777-300ERs to replace its 747-400 fleet from 2010.

The two carriers have also laid out plans to increase the Premium Economy cabins of their longhaul aircraft due to strong demand for the product, even in the poor environment. Joyce says that rather than passengers down-trading from Business Class, the demand for Premium Economy is coming from upgraders. “What you’re getting is definitely people trading up from Economy. There may be some trade down from Business. But that is positive for us in the current environment because you would be in a position where they would fully trade down to economy and the yields are a lot better and the profitability’s a lot better in Premium Economy,” he said.

Pain before gain

While the Australian economy appears to have remained buoyant and the wider world economy is showing some signs of recovery, none of the three carriers are expecting to see the market rebound over the next year, and have announced capacity cuts to continue matching it with demand, while cost cutting measures will also continue.

At Qantas, there will be further cost cutting measures under a new ‘Q Futures’ program, which aims to cut $500 million in costs over three years. While this will involve a number of initiatives, up to 1500 full time equivalent jobs are to be eliminated. In most parts, this will come from the reintegration of a number of units back under the Qantas Airlines banner, including Airports, Engineering and Maintenance and Catering.

Despite the poor conditions reducing the value of other airlines, Joyce has ruled out merging with another carrier in the near term. “A pre-requisite of consolidation occurring is the regulatory environment being such, the desirability of the carriers being there to allow it to occur, and the commercial terms being right,” said Joyce. “If you look at Qantas’s discussions with other carriers over mergers in the past, they’ve either fallen down because one of those different components hasn’t come together.”

For its part, Virgin Blue has not announced any more job losses, but still plans to cut domestic capacity by five per cent during the current financial year, primarily through lowering aircraft utilisation.

Air New Zealand has also announced that it expects capacity on its longhaul services to be down by 10 per cent, primarily as it down-gauges services from 747-400s to 777-200ERs, while it will also cut shorthaul capacity by seven per cent, with much of that to come from its trans-Tasman operations.

Although all three carriers are maintaining their plans to cut capacity, they have also signalled that yields are starting to stabilise, at least on a month-to-month basis. Virgin Blue said that yields from May to July have improved, “and whilst it cannot be considered a recovery at this stage it does indicate some stabilisation at least in the domestic markets.”

But despite signs of green shoots, Joyce was cautious to make any call on when the airline will return to the strong growth which has been its hallmark in recent years. “One of our guys, a revenue forecaster, claims there may be one swallow out there at the moment; you know, whether it makes the spring or summer is probably too early to say. But it certainly hasn’t continued to worsen for us.”

However, external pressures are starting to build on the industry again. Fuel prices have persistently remained close to US$70 per barrel, and should the global economy rebound quickly it is expected that fuel prices will rise with similar vigour.

As a result, optimism is being tempered. “While demand is stabilising, yields remain under significant pressure, fuel prices have resumed an upward trend and we are unlikely to achieve the same level of net hedging gains,” said Air New Zealand’s John Palmer. “The same agility displayed in the 2009 financial year will be imperative through the next year.”

While feeling the pain of the current market conditions, Virgin Blue and Qantas have both readied their war chest for the recovery with capital raisings earlier this year designed to boost cash balances. Both airlines have also shown that they stand ready to reactivate grounded aircraft should there be a need to reinstate the capacity withdrawn over the last year – although when and of what magnitude that recovery will be is not certain.

To do so though will be a delicate balancing act between managing demand and costs, particularly if fuel once again becomes an issue. It is also likely to be some time before any recovery will allow the airlines to reach levels of profitability seen in recent years. As such Qantas and Air New Zealand refused to give any specific profit guidance, while Virgin Blue says it expects to reach breakeven over the next year.

Perhaps the situation is best summary of the situation is from IATA’s Director General and CEO Giovanni Bisignani: “Demand may look better, but the bottom line has not improved. We have seen little change to the unprecedented fall in yields and revenues. The months ahead are marked by many uncertainties, including the price of oil. The road to recovery will be both slow and volatile. In the meantime, the industry remains in intensive care.”