Fight or flight
Qantas and Virgin Blue have responded to higher oil prices by dropping routes and reducing the frequency of some flights. At least one group of analysts says that if prices are maintained, they won't be able to survive.
So, JP Morgan analysts believe Virgin Blue won't survive if jet fuel costs remain at current levels for years. The more interesting conclusion would be that, if fuel prices remain at current levels for years, there won't be a significant airline in the world that survives and it won't only be airlines that are in real trouble.
As it happens, the analysts have clarified their position, saying the potential for Virgin' Blue's insolvency was simply a "scenario analysis" that had been misinterpreted by the press. They actually expect the airlines to remain profitable over the next few years. That isn't to say that the aviation industry, here and offshore, isn't facing massive and unpleasant dislocation.
Virgin Blue, like Qantas and every other airline in the globe, is suffering from the record oil prices and their impact on jet fuel, which accounts for around a third of airline costs.
Qantas, which made $1 billion pre-tax last year, has said that higher fuel costs would add $2 billion to fuel costs next year. While it has maintained its forecast of a 40 per cent increase in profits this year, if Qantas did nothing its profits would be wiped out if fuel costs remain at current levels.
Of course, neither Qantas nor Virgin Blue is going to do nothing in the face of the biggest challenge either has confronted since Virgin Blue launched eight years ago.
Qantas has cut both domestic and international capacity by five per cent, dropped routes and reduced flight frequencies. It will also substitute the lower-cost Jetstar services for Qantas flights on less profitable routes as well as retiring older and less fuel-efficient aircraft.
While the scenario analysis said that Virgin Blue would have to increase fares to survive, both Qantas and Virgin Blue have already increased fares. Virgin will, however, do something similar to what Qantas has announced. It will (as airlines around the world are doing) cut some unprofitable routes from its network, reduce the frequency of flights, mothball less efficient planes and cancel orders for new ones if it has to.
Like Qantas, the most affected routes will be the low-margin leisure routes and, like Qantas, it will do everything it can to avoid undermining the network benefit of being able to offer higher-margin flyers, particularly business flyers, seamless connectivity.
Brett Godfrey's much-discussed "New World Carrier" strategy, under which Virgin Blue shifted its positioning from a true value-based airline towards one with a few more frills has given it a share of the slightly less price-sensitive business and government markets. It won't surrender those gains and the degree of shelter they provide the airline with lightly.
But if fuel prices remain at current levels for a sustained period then both Qantas and Virgin Blue will have to make much tougher decisions.
The fact that they operate in a domestic market dominated by two carriers and three brands provides some ability to pass on the increased costs. Tiger, as the newest and probably the lowest cost operator, will have some impact on their pricing, particularly at the low-margin end of the market, but the Australian market isn't as competitive as most major offshore markets.
Both of them are also carrying a lot of cash in their balance sheets and have options to monetise non-aviation assets, like their frequent flyer programs or freight businesses if they need the cash to get them through a sustained period of poor profitability or even losses.
The obvious response to the current cost settings would be to cut capacity a lot further – Qantas by retiring a lot more of its older planes and Virgin Blue by effectively cancelling the orders it has for new planes. Despite the environment there is a shortfall in the supply of new aircraft, Virgin Blue could take advantage of that to sell its orders back to the manufacturers or their customers.
Between Qantas, Jetstar, Virgin Blue and Tiger the growth in capacity this year was approaching just under 20 per cent. As the economy slows and higher fares have an impact, that increase in available seats is almost as big an issue as the fuel price increases and threatens to further undermine profitability.
The capacity Qantas has taken out of its network, and the capacity Virgin Blue will take from its, is only a tentative step while they wait to see whether the oil price subsides. If it doesn't, they will have to hack more significantly into both their schedules and capacity by grounding a lot more planes.
That's the option of last resort for Godfrey, given that it would impact Virgin Blue's potential market share if the jet fuel price were to fall back. He would probably prefer to park planes, at a cost of about $US3 million a plane per year, for a year or so (it has about $750 million of cash) while he waits for the future of the fuel price to become clearer. He can also cut back on capital expenditure and operating costs to blunt some of the impact of soaring costs.
This is an incredibly testing time for airlines. In particular, because they know it is improbable that fuel prices will fall back dramatically. It is equally testing for makers of large cars and for any industry that can't readily pass on the higher costs to its customers without suffering losses of volume and margin.
On the positive side, Qantas and Virgin Blue are large, very well-run airlines with relatively low cost bases. They benefit from operating in an economy riding a boom in natural resources and a market where the competitive intensity is constrained by the reality that there are only two serious competitors.
They have a lot more going for them than most of their international peers. That may not save them if jet fuel prices remain at current levels for several years, but they should last a lot longer than most.
As it happens, the analysts have clarified their position, saying the potential for Virgin' Blue's insolvency was simply a "scenario analysis" that had been misinterpreted by the press. They actually expect the airlines to remain profitable over the next few years. That isn't to say that the aviation industry, here and offshore, isn't facing massive and unpleasant dislocation.
Virgin Blue, like Qantas and every other airline in the globe, is suffering from the record oil prices and their impact on jet fuel, which accounts for around a third of airline costs.
Qantas, which made $1 billion pre-tax last year, has said that higher fuel costs would add $2 billion to fuel costs next year. While it has maintained its forecast of a 40 per cent increase in profits this year, if Qantas did nothing its profits would be wiped out if fuel costs remain at current levels.
Of course, neither Qantas nor Virgin Blue is going to do nothing in the face of the biggest challenge either has confronted since Virgin Blue launched eight years ago.
Qantas has cut both domestic and international capacity by five per cent, dropped routes and reduced flight frequencies. It will also substitute the lower-cost Jetstar services for Qantas flights on less profitable routes as well as retiring older and less fuel-efficient aircraft.
While the scenario analysis said that Virgin Blue would have to increase fares to survive, both Qantas and Virgin Blue have already increased fares. Virgin will, however, do something similar to what Qantas has announced. It will (as airlines around the world are doing) cut some unprofitable routes from its network, reduce the frequency of flights, mothball less efficient planes and cancel orders for new ones if it has to.
Like Qantas, the most affected routes will be the low-margin leisure routes and, like Qantas, it will do everything it can to avoid undermining the network benefit of being able to offer higher-margin flyers, particularly business flyers, seamless connectivity.
Brett Godfrey's much-discussed "New World Carrier" strategy, under which Virgin Blue shifted its positioning from a true value-based airline towards one with a few more frills has given it a share of the slightly less price-sensitive business and government markets. It won't surrender those gains and the degree of shelter they provide the airline with lightly.
But if fuel prices remain at current levels for a sustained period then both Qantas and Virgin Blue will have to make much tougher decisions.
The fact that they operate in a domestic market dominated by two carriers and three brands provides some ability to pass on the increased costs. Tiger, as the newest and probably the lowest cost operator, will have some impact on their pricing, particularly at the low-margin end of the market, but the Australian market isn't as competitive as most major offshore markets.
Both of them are also carrying a lot of cash in their balance sheets and have options to monetise non-aviation assets, like their frequent flyer programs or freight businesses if they need the cash to get them through a sustained period of poor profitability or even losses.
The obvious response to the current cost settings would be to cut capacity a lot further – Qantas by retiring a lot more of its older planes and Virgin Blue by effectively cancelling the orders it has for new planes. Despite the environment there is a shortfall in the supply of new aircraft, Virgin Blue could take advantage of that to sell its orders back to the manufacturers or their customers.
Between Qantas, Jetstar, Virgin Blue and Tiger the growth in capacity this year was approaching just under 20 per cent. As the economy slows and higher fares have an impact, that increase in available seats is almost as big an issue as the fuel price increases and threatens to further undermine profitability.
The capacity Qantas has taken out of its network, and the capacity Virgin Blue will take from its, is only a tentative step while they wait to see whether the oil price subsides. If it doesn't, they will have to hack more significantly into both their schedules and capacity by grounding a lot more planes.
That's the option of last resort for Godfrey, given that it would impact Virgin Blue's potential market share if the jet fuel price were to fall back. He would probably prefer to park planes, at a cost of about $US3 million a plane per year, for a year or so (it has about $750 million of cash) while he waits for the future of the fuel price to become clearer. He can also cut back on capital expenditure and operating costs to blunt some of the impact of soaring costs.
This is an incredibly testing time for airlines. In particular, because they know it is improbable that fuel prices will fall back dramatically. It is equally testing for makers of large cars and for any industry that can't readily pass on the higher costs to its customers without suffering losses of volume and margin.
On the positive side, Qantas and Virgin Blue are large, very well-run airlines with relatively low cost bases. They benefit from operating in an economy riding a boom in natural resources and a market where the competitive intensity is constrained by the reality that there are only two serious competitors.
They have a lot more going for them than most of their international peers. That may not save them if jet fuel prices remain at current levels for several years, but they should last a lot longer than most.
Share this article and show your support
Call 1300 880 160
Start a chat
Schedule a call
