KGB TV: Qantas chief Alan Joyce

The Qantas chief executive explains how the relationship between the Australian dollar and fuel prices has ruptured, why he's content to taper capacity growth faster than Virgin, and where his board stands on dividends.

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The Qantas chief executive tells Robert Gottliebsen and Stephen Bartholomeusz:

The five-year plan for Qantas International to return capital in 2015 is on track, despite potential headwinds like rising fuel prices.

The traditional correlation between fuel costs and the Australian dollar has broken down for the second time since the Gulf War, so the lower currency has had no net benefit for Qantas so far

– There is good growth potential in its frequent flyer scheme, in domestic and corporate markets.

– He is content to taper capacity growth quicker than Virgin because Qantas has a high-yield advantage in both the corporate market, where it has the bulk share, and the low-cost market through Jetstar.

–  The board is keen on switching back to dividends payouts but he can't specify a time frame

Stephen Bartholomeusz: Alan, thanks for joining us.

Alan Joyce: It’s good to be here, Steve.

SB: In what was a pretty difficult year to June, you actually almost halved the losses in your international business. Was that in line with or ahead of the strategic timeline that you had?

AJ: It’s in line with the strategic timetable. We still believe it will take three years to turn around Qantas International to break even in this position and we had a five-year plan to get it to return its cost account with all the Qantas brand businesses of Qantas Domestic and Qantas Frequent Flyer. We’re on track to deliver that and this year we saw a huge amount of improvements across the board: a very good cost outcome on Qantas International, a five per cent reduction in unit costs despite the business shrinking by six per cent. It shrunk because we exited loss-making routes.

And we also saw in that same year, with that cost reduction, record customer satisfaction results. So this is all about getting the balance right, keeping the customers, delivering on your product, delivering on better service, getting costs out, improving the economics and getting the business on track so that we can grow it again. And I think this was a good year on that five-year plan.

SB: I know the target is to break even in 2015; how much further progress do you expect to make this year? And how much of the contribution will the Emirates deal do?

AJ: The Emirates deal was actually a cost last year because building the hub from Singapore to Dubai actually cost us over $50 million and we weren’t on sale for our European destinations. We were a partner for a large period of time. We terminated [our partnerships with] British Airways, Cathay Pacific and Air France. We didn’t get the regulatory approval till February with Emirates and there were physical costs of actually relocating crews and infrastructure into Dubai, and so we won’t have that cost this year – we’ll have the benefits kicking in.

But of course we’ve only had some of the parts of the relationship, even though we’ve been very fast. We’ve had things like the trans-Tasman only begin in the last few weeks. So there’s still a build-up if that benefit is to come true. So it will help us and it will be a big thing. With the targets for international, I’ve always said – and excuse me for using an airline analogy – we’ve always said that we believe we will get to our break-even situation in that three-year period and to the return of capital in five years. There could be tailwinds, and there could be headwinds, and the tailwinds – they help you get there faster – are in the proved economic climate and the economies we fly to. We’re heavily leveraged to the US. We’re in over 50 per cent of that market. An improved position on fuel price – if fuel prices were to come down from the very high levels that they are – an improved position on currency and the weak Aussie dollar helps us.

But there’s potential for headwinds that slow you down. Like, the fuel price is at record levels today because of the geopolitical situation in Syria. If that was to continue, then that would be a headwind against us. Or if the economies were to go backwards from where we think they’re going to be; the Australian economy, for example. So we’re still confident of those targets, but we’re very conscious of the headwinds and the tailwinds that we could experience.

Robert Gottliebsen: What the progress is saying – obviously not uniformly – is the current year will be okay in terms of profit, earnings per share, but still depressed. The big increases in profit come in 2015 and particularly in the 2016 year. Does that roughly coincide with the way you see it?

AJ: Well, we’ve been very clear. We haven’t given an outlook statement on where we are in terms of our forecast for this year because of the volatility that’s there – and it is very volatile. Our prices have moved $3, $4 in one day. We buy 36 million barrels of fuel…

RG: If we leave this year out and we accept the volatility might take place, but the sort of momentum of the business is that if things are reasonable – things like oil and petrol prices – that the momentum of the profits, without quantifying it, should be in 2015 and 2016?

AJ: Again, I don’t give an outlook statement, and even commenting on brokers’ views is in our minds is confirming or talking about an outlook. So where we are and where we stand is that we have the target of getting international back to break even and return of capital.

RG: That’s 2015 or…?

AJ: Financial year 2015. And when you think of the impact it’s had on our earnings, the year before last $450 million, and $250 million last year, it –

RG: Loss?

AJ: Loss. It is a significant improvement once you get there in overall earnings. We do believe our Frequent Flyer scheme will continue to grow. We’ve talked about the fact that this has had double digit growth for the last five years. It made $260 million earnings before interest and tax last year. We see huge initiatives coming out over the next few years. The domestic market; we’re certainly holding our own in the corporate market; and our profitability, our share of the profit pool, has actually grown. So we do believe we’re in a very strong position and that’s –

RG: And that’s calm now, isn’t it? There aren’t wars going on all over the –

SB: Calm-er.

RG: Calm-er.

AJ: Calmer is probably a very good word for that. So at the 80 per cent capacity growth we had last year, it’s tailoring down. There’s still a big capacity growth in this year, a lot less than it has been in the past. That has meant in last year’s numbers, as an example, the Qantas Group the previous year made over $650 million. Last year we made $450 million. A hundred million of that impact is the carbon tax. The carbon tax we won’t be able to recover because of the surplus of capacity. Two years ago we thought we’d be able to recover it.

So the profit pool for everybody has shrunk. Actually, our share of the profit pool in financial 2012 was 85 per cent. Our share last year was a 120 per cent of the profit pool because everybody else was losing money. And so we’ve grown, but in a smaller profit pool overall. And that is capacity-related. So once the capacity situation is resolved, you should see the profit pool I think growing again.

SB: Will it be resolved? I mean you’ve said I think that you see capacity growth in the domestic market for your brands at 1.5 to 2.5 per cent. John Borghetti, your major competitor at Virgin Australia, has said three or four per cent excluding Tiger Airways. If they put three or four per cent capacity into their primary brand and ramp up Tiger, don’t you have to respond? Like, what, do you swamp them with more capacity?

AJ: Well, our position has always been clear. We believe – and we have believed for 10 years under the previous management and current management – that the profit maximising situation for the Qantas Group is to maintain 65 per cent. Now, it’s an easy headline to use. It’s more complex than that and in our investor presentation we have a great slide that I think describes the virtuous circles of the Qantas business and the Jetstar business, that I think is unique in terms of the structure that we’ve created for ourselves here.

And the virtuous circle we have is that for Qantas more frequencies, more destinations, more capacity at peak time means we appeal more to the corporate market. Appealing more to the corporate market means we maintain the bulk – in this case last year, 84 per cent in Qantas with the corporate market. That gives us a yield premium, that gives us a margin premium. That margin lends us to reinvest in product, aircraft, lounges; and allows us to continue to grow, and that allows us to retain the corporate market and the virtuous circle continues.

And in the low-cost market at the scale that Jetstar has in the leisure market, in every market in the world, it’s been proven the large local player – and I know competing against Ryanair when I worked in Europe –  they have a presence in terms of marketing and a scale advantage that gives it a lower cost base. That gives Jetstar a yield, a margin premium. That margin allows Jetstar to continue to grow and continue to see where they have a really strong position in the leisure market, and that scale advantage is something that every low-cost carrier around the world regards as precious and gives you a significant advantage above businesses and the two of them together work really well hand in hand uniquely.

I mean, we’re the only market in the world where the full service carrier has created a low-cost carrier successfully, and a major competitor which was a low-cost carrier completely changed the strategy. My colleagues in Europe say, ‘You’ve defied gravity here. How has this happened in this market? We’re all suffering in the Western world. Your competitor waved the white flag, changed strategy overnight and went in a completely different direction.’ This is a unique structural advantage we’ve created for ourselves, so we’re not going to give it up lightly.

RG: In terms of Jetstar you’re attempting to get a major operation in Asia. What’s your timeframe of success, and what’s your criteria? What do you expect in say 2015 or 2016 as your benchmark of success in that?

AJ: It is an investment for the long term and we are investing in setting up a number of new businesses, as you know. The Japanese business is an example for us. It’s going fantastically well, but it has cost us money to set this business up and we have been impacted by things like a weaker yen and more competitive aggressiveness at the start when we started this business. But you look at where we are now – we’re the largest low-cost carrier in the Japanese market. We’ve got the biggest operation at Narita of the low-cost market; the highest seat factor; the best on-time performance, and for the Jetstar brands its net promoter score – its customer satisfaction – it’s the highest in Japan.

Now, that surprised us because it’s a more discerning market in Japanese customers, but it shows you the product that we’re delivering. And the Japanese market has had stagnant growth for 10 years, like the economy. Last year we’ve had a nine per cent growth in passengers travelling in Japan because of the low-cost carriers. And a major competitor, Air Asia, has walked away from that market – the first market it walked away from. So we’ve now got the two low-cost carriers essentially – All Nippon Airways' Peach, and Jetstar. It’s a great position for the future in a market six times as big as Australia. But we always said it would be three years before these businesses would get into profitability.

Hong Kong, similarly, we are setting up a new business there. We’ve got great a shareholder with Pansy Ho, and Shun Tak just bought in 33 per cent of the business. She has agreed to become chairman of the company, which is fantastic. This is a Hong Kong company with Hong Kong management, a Hong Kong board, and we are going through the approval process. And I think that will be a great business also in Hong Kong. We’ve got the Singapore business making money. The Vietnam business where our partner, Vietnam Airlines, they’re going through a massive transition and that’s on track to make money.

So these businesses all go together because it is self-reinforcing and a rising tide. And I think a lot of Aussie companies – I know you talk to a lot of chief executives – talk about breaking into Asia. And you think, in the last year we’ve created a $500 million business in Japan. We’ll have a $500 million business in Hong Kong in the next few years.

These businesses are giving us a larger presence in Asia than we’ve ever had before and a lot of Aussie companies are talking about the fact that we’re doing it. And this is going to be great for the company in the long term – and it’s a long term investment for us to get there.

Now, our shareholders will see returns in a number of different ways. These are investments that for us in the long term we believe we can release value for our shareholders. They’re not like Jetstar in Australia where you have to own 100 per cent of them and we don’t, we own 33 per cent of Japan and 33 per cent of Hong Kong and 49 per cent of Singapore; 20 per cent or 30 per cent of Vietnam. But there are long-term potential returns for our shareholders through a number of dimensions and we’re pretty excited about the penetration we’re making in Asia.

RG: So in about 2016 you’ll really get a picture as to whether this is really going to be a big business?

AJ: Well, I know today it’s going to be a big business. The 2016 is the returns that you’re going to get from these businesses, an indication of all of the businesses being on track and having gone through the initial investment phase, which for airlines usually typically takes that three-year period for them to get a return.

SB: If we go back to that capacity issue, for most of the period post the global financial crisis we’ve seen big increases in capacity into this market from our international carriers. I assume that was partly about the strength of the dollar and the attractive yields in their local currency terms that were available in this market. Since April, the Australian dollar is down 15 per cent. Has that had any impact on competitors?

AJ: It’s a great question, Steve. I think it’s a combination of things. The Aussie dollar was very strong and the Aussie economy was very strong, and people were looking at the best place to put their capacity. It certainly wasn’t Europe, it certainly wasn’t the States, and Australia was a great place to move these mobile assets. So we’ve had this huge growth coming into this market, which has had an impact on yields. We’ve seen our cost base relative to our competitors blow out because we’re an Aussie-based airline. Our fleet was bought in Aussie dollars and our labour, which is a big part of our cost base outside of fuel. So we believe absolutely that the weak Aussie dollar in the long term is better for Qantas.

And it has a number of factors. First of all, it means our cost base has narrowed and will narrow against the competition. It means they get less revenue from Australia. We’ve worked out for our total competition flying in – so the major carriers flying into Australia – this movement in currency has taken around $700 million in revenue from them just in the movement in their local currency. There’s less incentive for us to add capacity to this market.

It means our foreign revenue is actually worth more in Aussie dollars, and it probably means in the long term fewer Aussies going overseas once it gets weaker. We are potentially the beneficiary of that, because they’re probably going to travel domestically which, since we have 65 per cent of the domestic market, gives you a benefit as well. So the business overall gets a benefit out of the weaker dollar.

The only problem we have at the moment is there has always traditionally been a correlation between the Aussie dollar and fuel prices. For only the second time in the history – I think the last time was the first Gulf War – that correlation has broken down. We’ve now got in Aussie dollars the fuel price is up around quite high levels, and in our outlook statement for this year we did point out in this half we will have $160 million more in fuel costs compared to the previous six months of last year. In fact, if you look at oil prices, they are extremely high compared to what they were in the past. Last year we paid $600 million dollars more in fuel costs than we did the year before the global financial crisis – $600 million dollars. And this year it looks like it’s going to be even bigger than that if the situation in Syria continues.

SB: But on balance, is a lower dollar in net terms better for you?

AJ: It is. Except this fuel cost is negative for us. And if the cost correlation is re-established, absolutely it’s better. Not at the moment with the fuel costs being this high.

SB: Is it said that United’s taken capacity off the trans-Pacific because of the change in the dollar? Is that true?

AJ: Yeah. United has announced a schedule change from next April where they’re changing the aircraft they operate from a 74 to a 777. That takes six per cent out of the market in total. It’s nearly the equivalent of Delta being removed from the market. We think part of that is product changes and the retirement of the fleet, but it could be also as a consequence of the changes in the dynamic. We’ll see over time whether the belief is that foreign carriers will have less incentive to add capacity here. We’ll see that develop over time when the Aussie dollar actually confirms where that’s going to settle.

RG: Alan, you have been buying back shares, which is something that pleases the big institutional shareholders. But is absolutely hated by the major group of superannuation holders, the small self-managed funds and people like Australian Foundation who represent them. Are you going to just keep buying back? When can we actually see some dividends?

AJ: For us, I suppose we look at a capital management in a broad aspect. What’s great about where Qantas has got itself to is we’ve done the big investment over the last few years of renewing our fleet and we had a period of time where we were spending $2 billion to $2.5 billion dollars every year on the renewal. There were periods of time in our past where we hadn’t renewed the fleet and we had to do a bit of catch-up. It’s now the youngest fleet in two decades. The bulk of the hard work has been done. We see capital expenditure going forward to reduce to at the more maintenance levels of between 1.0, 1.1 and 1.2. That means the business is generating surplus cash, has generated cash for the last two halves, positive free cash flow. 

So we’re looking at paying down debt and appropriate capital management. In the last year, for example, we paid down a gross amount of $1 billion dollars in debt. We think capital management is extremely important. There are two choices: there’s the dividend or the buyback. For a lot of our shareholders, paying a dividend that is not franked is an issue and, because of our accelerated appreciation on the aircraft, we have low levels of franking credits.

What we believe, given our share price the way it is today, there’s good value in buying back those shares and it’s going to be positive NPS for our shareholders in the long term. Last time we issued equity, it was over $1.80. Now we’re buying back shares at $1.30, $1.40. So in the long run we believe that will be positive for all of our shareholders and positive earnings per share from the buyback.

RG: Perhaps later you will go to dividends.

AJ: Yes. The board is very keen on switching back on dividends. They believe that dividends are the appropriate thing to do in capital management, but the balance between what we do in share buyback and what we do in dividends depends on what we believe is the franking outlook, the ability to pay franking credits and where the share price sits.

RG: So when will you pay tax, do you think?

AJ: Don't know... Good try, Bob, but I'm not going to be able to answer that!

SB: We could keep this conversation going indefinitely, but we shan’t. Thank you very much indeed for your time, we appreciate it.

AJ: Thanks, Stephen. Thank you. Thanks, Bob.

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