Airlines always a risky business

The Plane Game involves high fixed costs and airlines operate in a deregulating and increasingly competitive market.

As the biggest economic downturn in memory rolls around the world, they are stationary targets. Full-fare operations are the most exposed because the slump feeds in from the top down.

Banks, big corporations and those who serve them, including lawyers, investment bankers and accountants, were hit earliest. They have laid off staff and contractors and cut travel budgets, and it was their people who habitually travelled at the front of the Airbus.

Another aspect of this economic slump is that its sudden intensification in the December quarter saw stocks pile up and shipments including air freight shipments plunge: both factors are behind the announcement by Qantas's chief executive, Alan Joyce, that pre-tax profit guidance for the year to June 30 has been cut from $500 million to between $100 million and $200 million.

Demand for premium international seats has slumped by between 10 to 20 per cent depending on the route. Freight volumes are also down sharply. Carriers are cutting prices to try to maintain volumes and Qantas is meeting the competition. To not do so would be to risk a damaging shift in market share, but the result is a yield and profitability crunch.

Yesterday Qantas said the slide in premium seat demand was unprecedented, and in some senses it is: for magnitude, it bears comparison with the slump that followed the September 11, 2001, terrorist attacks.

But it will probably last much longer and there will be a weaker domestic market counterweight for the Flying Kangaroo.

The 2001 terrorist attacks hastened Ansett's collapse and Qantas's domestic market share spiked to 90 per cent as a result.

It has about 65 per cent of an Australian market that is still cushioned from the worst of the global downturn. Joyce says it should hold on to it because the airline that replaced Ansett, Virgin Blue, is also cutting capacity.

Another Ansett-style windfall for Qantas is not on the horizon. There will be no domestic profit leap to offset the savage erosion of international earnings.

Declining demand and discounting became a concern in the final quarter of last year after serious talk about a total financial system meltdown began circulating.

Joyce had believed the industry would be bumping along the bottom by now: he says now he doesn't know when that will be..

Joyce says job cuts are necessary to protect Qantas from the economic storm and position it for recovery, and he's right. But the patches he is applying underline the intensity of the dowturn, and emphasise the sensitivity of airlines to external shocks - a sensitivity that undermines the long-term retail sharemarket case for investing in them.

Qantas's international arm is losing money now. The increasingly competitive trans-Pacific route is doing the worst. The group's $100 million to $200 million pre-tax profit guidance for the full year means the first half pre-tax profit of $288 million will be followed by a June half loss.

And that will be after Qantas books a $150 million boost from an accounting change on the treatment of frequent flyer points accumulated outside flights, neatly offsetting a similar amount it will charge to cover job losses and aircraft delivery deferrals. Without the accounting change, Qantas would be warning about a full year loss, too.

Qantas has $3.2 billion of cash on its balance sheet, and no significant debt principal repayments due until February 2011. It is one of the best-balanced airline businesses, with a domestic operation that inherits custom from its international routes and a discount airline in Jetstar that is not as vulnerable as the full-service brand because it relies less on business travel and is not loaded as heavily with fixed costs.

The group is poised between profit and loss at a time when others have already fallen over. Late last month, the industry body the International Air Transport Association raised its estimate of losses worldwide in 2009 from $US2.5 billion ($3.4 billion) to $US4.7 billion, citing a deterioration in Asian air markets. The association also predicted there would be no recovery until 2011, so Joyce and Qantas's shareholders are in for a long-haul, low-altitude flight.

After being as low as $1.74 on the downgrade news, Qantas shares fought back in a strong market to be down 4c, or 2 per cent, to $2 yesterday.

That was a thumbs up for Joyce's plan. The broader point for retail investors is that airline earnings are inherently unreliable.