Pushing ahead

“The result was underpinned by strong performances across the Qantas Group with Qantas Airlines returning to its position as the most profitable domestic airline, and both Jetstar and Qantas Frequent Flyer had record profits,” said CEO Alan Joyce.

That saw Qantas’s flying operations deliver underlying earnings before interest and tax (EBIT) of $67 million for the year. That was despite a 6.3 per cent decline in capacity, and was also assisted by an 8.3 per cent decline in costs, including fuel. In part, this was due to the effect of the QFutures cost cutting program, which delivered $533 million in cost cuts this year, outperforming the $500 million target.

Jetstar also had another strong year, setting a new record for its earnings with an EBIT of $131 million as it saw a major growth across its operations in Australia and Asia. “For any business to take 28 per cent growth in capacity and grow profitability by 22 per cent in any year, in any industry is a great, and that’s what we’ve got from Jetstar, so we’re very happy with its performance,” said Joyce.

While apparently strong, for both carriers the bulk of the good fortune came in the first half of the financial year, with further analysis showing that in the second half Qantas only recorded an EBIT of $7 million while Jetstar eked out $10 million, which was blamed largely on the seasonal weakness of the second half, as well as various financial measures.

Airlines aside, the clear standout for the Qantas Group was Qantas Frequent Flyer, which contributed an EBIT of $328 million for the year or a whopping 45 per cent increase on the year prior. That would again appear to prove the theory that it is more lucrative to run an airline-based loyalty program than an airline itself.

Also of note was Qantas Freight, which managed to deliver $42 million EBIT for the year. Despite freight yields decreasing by two per cent compared to the prior year, an increase in volumes of seven per cent helped to push the freight operation forward.

Following Qantas’s result, Virgin Blue announced that its net profit before tax came in at $34.3 million, with a 13.1 per cent increase in total revenue to $2.98 billion, while operating expenses increased by 10.5 per cent to $2.89 billion. Its short haul operations recorded earnings before interest and tax (EBIT) of $127.6 million, which was up 88 per cent on the same time last year. Long haul services recorded an EBIT loss of $43 million for the year, which was a 39 per cent improvement on the previous year. Over the year, the airline’s yield declined by 7.1 per cent to 10.06 cents per ASK despite a 4.9 per cent reduction in cost per ASK excluding fuel.

Virgin Blue’s results came after it had already hosed down expectations of a return to larger profits, with the carrier issuing a profit warning in May, slashing its expected profit from $80 million to between $20-$40 million. In that context, the profit came in toward the higher end of that estimate, helped largely by stronger than expected performances in key markets.

“Our shorthaul business made a credible underlying EBIT of $20 million in the second half of the year,” said CEO John Borghetti in delivering his first full-year result. “In addition our long haul business has seen improvements, particularly into the US.”

Across the Tasman, Air New Zealand performed well despite a six per cent fall in normalised earnings to NZ$137m (A$107m) as revenue decreased by 12 per cent to NZ$4bn (A$3.14bn). Passenger demand (in revenue passenger kilometres) decreased by 4.7 per cent and yield fell by 10.7 per cent on long haul services and 5.4 per cent on short haul. An overall decrease in capacity of eight per cent resulted in load factor increasing by 2.8 percentage points to 83.1 per cent.

Meanwhile, at the regional level, things appear to have been better for Regional Express, which recorded a 7.2 per cent increase in full year profit after tax to $24.6 million. That was despite a 5.4 per cent fall in passenger revenue to $193.2 million, while total group revenue was down 8.5 per cent to $229.7 million. Passenger numbers were down five per cent to 1.238 million, while load factor declined by 4.2 percentage points to 61.9 per cent.

“Fortunately, through sound financial management, Rex was able to take full advantage of all the fiscal initiatives put in place by the government to assist the economy,” said Rex chairman Lim Kim Hai. “Together with efficiency gains and careful attention to costs, we were able to overcome the deficit of revenue to achieve a very satisfactory outcome.”

Domestic Dynamics

As with last year, the numbers seem to indicate that Qantas and Virgin Blue in particular again relied upon a reasonably buoyuant domestic market to offset losses on their international services.

That buoyancy is possibly best shown in the BITRE figures for the year ending June 30, which compared to the previous year show a three per cent increase in the number of passengers travelling domestically. The figures also show that load factor across the industry increased marginally from 78.6 to 79.5 per cent.

Yet, the financial figures also tell a tale of two vastly different six month periods. For the six months to December 31, Joyce noted that Jetstar was able to extract additional yields and became the most profitable carrier domestically, while the second half was a completely different story.

“In the second half that completely changed as the premium market came back and Qantas became the most profitable carrier followed by Jetstar,” he said. “So that’s a clear indication that there are different dynamics happening at the leisure and the business end and the leisure end is being impacted by the level of capacity that’s been added.”

Part of that may be related to the return of business traffic, which has seen healthy increases on key routes, such as the Sydney-Melbourne-Brisbane triangle. Joyce also noted that Qantas has held its ground in the sector. “We maintained all of our key corporate accounts during the year (and) we’re seeing good growth in the SME market share.”

It is those accounts which are now the target for rival Virgin Blue, with Borghetti moving to reduce Virgin’s reliance upon the volatile leisure market and more towards the corporate and business markets.

The rewards of doing so are not insignificant for Virgin Blue. “For every percentage point that we win of market share in the corporate market, our corporate yields go up by over one percentage point,” Borghetti said.

At some level, it appears that Virgin Blue has started making inroads into the business market, with yield over the financial year increasing by 2.9 per cent. It has also had major wins in being selected as a member of the Federal Government’s air travel panel, while it has also secured an exclusive agreement with the National Broadband Network Company.

Nevertheless, Borghetti says that the carrier is not completely backing away from the leisure market where it started 10 years ago. “We are not taking (the airline) away from leisure. We are going to continue to focus on the leisure part of the market, but what I am saying is we are going to focus on the corporate part of the market more.”

While both Qantas and Virgin Blue make plays for the lucrative business and government clients, there are also some interesting moves ahead with the carriers’ plans to add capacity, albeit somewhat cautiously.

Qantas says that it plans to add 9.6 per cent capacity to the market, with the carrier announcing in August plans to add more widebody domestic services, while in early September, Jetstar CEO Bruce Buchanan hinted in an interview that Qantas may also return to some of the routes it had ceded to Jetstar and operate alongside the budget carrier.

As in years previous, a large amount of the Qantas Group’s domestic capacity growth will come from Jetstar, which has announced a number of new frequencies to key leisure destinations such as Launceston, Cairns and Perth. Those increases are part of plans to increase Jetstar’s domestic capacity by up to 30 per cent over the year ahead.

On its part, Virgin Blue is planning to add between six and eight per cent capacity over the next year, although Borghetti says that this is not a fixed number. “The truth is that what we’re saying is that we have the ability to flex capacity,” he said. “We’re saying 6-8 per cent because we think that’s about the right amount of capacity for the market growth that we believe is going to be out there and to return the optimal yields that we believe in.”

Some of that increase in capacity will come from two A330-200s which will enter service with the carrier over the next year, and will be focused on trans-continental services from Perth. So far no details of the product to be offered have been released, but it is widely expected that the A330s will feature a new Business Class cabin.

Borghetti has also decided to cut the six 78 seat Embraer E-170s it uses on regional services, noting that the aircraft were “not an economically viable aircraft…on the missions we fly them.”

Virgin Blue has not yet announced if that will see it exit from the regional markets such as Canberra, Port Macquarie and Mildura, key markets it has tried to compete against QantasLink on as part of earlier attempts to make inroads in the corporate and government markets. As such, many expect that the aircraft could be replaced by more economical turboprops. Alternatively, it may pursue a closer relationship with Regional Express to provide feed to its network from those ports.

With the large increase in capacity in the leisure market over the past six months, it appears that the competitive pressure is set to lessen slightly, with Tiger Airways announcing that it will reallocate two A320s which were to be delivered to its Australian operations to its Singapore base. That appears to have thrown into doubt how rapidly the discount carrier is willing to grow in Australia over the next year, and will no doubt lessen some of the urgency of Jetstar and Virgin Blue to add capacity. Indeed, the airlines may hold off adding capacity in order to preserve yield.

As the domestic capacity increases appear relatively subdued, there appears to be an easing in the pressure on market share. Borghetti has signalled that he does not intend on adding capacity in order to make inroads on Qantas’s 65 per cent line in the sand. “We are not here to win market share at all costs, we are here to return our shareholders a return. For us, the right market share is an economic argument. It is the level that is appropriate to get a return for our business and our shareholders,” he said.

International Trials

With domestic operations largely performing well under the circumstances, the international operations of Qantas and Virgin Blue remained challenging although signs across most markets are turning positive.

In response to the continued poor conditions, Qantas slashed its international capacity by 9.4 per cent in response to falling yield in its premium cabins, which reached their lowest point during the first half of the year. Over the year, international passengers were down by 18.5 per cent, while revenue passenger kilometres fell by eight per cent.

Not helping it was the European volcano which it says cost it $46 million from the bottom line, while the civil unrest in Bangkok also had an impact on some of its services.

Yet, Qantas CEO Alan Joyce said that yields on its international services are starting to improve, as the affects of the global financial crisis, which started showing during the final quarter of the year. “In the last quarter, we saw international yields up over 12 per cent on the previous year. That shows again that the premium market is coming back and our international business is coming back to where we need it to be,” he said.

“We’re seeing overall yield recovery continuing, but it is still below the pre-GFC levels in 2008. We believe that gives us huge leverage in terms of the recovery going forward,” said Joyce.

There are signs that Qantas is ready to restore its international capacity, with the carrier upgrading from an A330-200 to a Boeing 747-400 on most of its Sydney-Tokyo services in recent months. It is expected that the key US and UK markets will also see growth as higher capacity A380s take over on those routes as more arrive over the coming year.

There are also large plans to continue the international growth of Jetstar over the next year, with the carrier already planning to add more capacity to the domestic New Zealand market and its Asian operations.

For Virgin Blue, the sea of red ink for its V Australia longhaul operations continued, although its EBIT loss was reduced by 39 per cent to $43 million as the airline increased the utilisation of its fleet and revenue loads, in part by redeploying its fleet away from the Pacific to other routes in Africa and Asia.

But it is the future which is proving more intriguing when it comes to V Australia, with Borghetti using the profit announcement to reveal new plans for the longhaul arm which will see it concentrate primarily on services to Los Angeles and Abu Dhabi as it drops its Phuket and Johannesburg routes.

Borghetti explains that those routes do not make sense for it going forward. “On a lot of the markets that we were selling with 777s, although it was appropriate at the time, as we go forward in this new strategy those markets aren’t appropriate – both in the sense that they were losing considerable amounts of money with no prospects of marking money and also strategically,” he said.

Instead, V Australia’s services will depend in large part upon providing feed for its alliance partners as well as Virgin Blue’s domestic services with its fleet of five Boeing 777s. This will see it focus on feeding passengers through Los Angeles onto Delta services, while also starting new services to Abu Dhabi to feed new partner Etihad Airways.

By focusing on these major hubs, Borghetti says that the small airline will be able to achieve the reach of a much larger carrier. “With a small number of aeroplanes, by operating into two key hubs in Los Angeles and Abu Dhabi we open up hundreds of destinations,” he said.
But in September a stumbling block to this strategy emerged, with the US Department of Transport announcing a tentative decision to deny it antitrust immunity as it was not in the best interest of consumers. As Australian Aviation went to press, both Delta and Virgin Blue indicated that they work with the DOT to overturn the interim decision.

Closer to home, Virgin Blue’s proposed trans-Tasman tie up with Air New Zealand will be another major focus for the carrier.

Predominately, it is expected that the alliance will help to rein in some of the competition on those routes, and provide greater reach for passengers on both sides of the Tasman. That alliance appears to be more important than ever for Virgin Blue, particularly with the announcement of its withdrawal from the domestic New Zealand market from October.

Clear air ahead?

Despite the clear plans put forward for both Virgin Blue and Qantas, neither company has been game enough to issue profit guidance for the year ahead. That appears prudent, given the varying fortunes of an industry which in recent times has been exposed to a great deal of volatility, both from internal and external sources.

Domestically, it will be an interesting game to see what happens in both the leisure and business markets. With a new brand and range of products likely for Virgin Blue, it will remain to be seen over the next year if it can break the stranglehold of Qantas in the corporate market while also avoiding the capacity bloodbath at the leisure end.

Internationally, it seems that Qantas is keen to once again start restoring capacity where there is yield for it. However, its challenge, as always, will be to ensure that it can compete with the growing likes of the Middle Eastern and Asian carriers which have made major headway into the Australian travel market.

No doubt it will also face challenges from the new Virgin-Etihad tie up on services to the UK and Europe, while the Virgin-Delta relationship could also prove a worthy competitor to Qantas’s dominance on the trans-Pacific routes.

For all of the predictions of the airlines, a year is a long time in aviation and plans will likely change before the next full year profits are reported. Despite demand and prices recovering and the airlines once again hitting the growth button, their relative conservatism shows that there are a number of variables which could still have an impact on them over the year. How they respond to those will only be shown in the fullness of time.