Qantas charts its path towards a turnaround

Qantas and its chief executive Alan Joyce have been the targets for a lot of vitriol in recent years, peaking when the airline announced a gut-wrenching $2.8 billion loss last financial year. Today's market update, however, says emphatically that Joyce has navigated the group through the nadir of its fortunes.

The underlying earnings before tax of between $300 million and $350m for the first half of this financial year that Joyce foreshadowed today represent a massive ($550m-$600m) rebound from the $252m of losses incurred in the first half of last year.

Moreover, beyond being the best first-half result Qantas has experienced since 2010, all its divisions, including an international business that has been haemorrhaging at an alarming rate in recent years, are profitable, Joyce said.

The two big drivers of the turnaround in Qantas are the competitive context in which it is operating and its own quite dramatic transformation program.

The sea of red ink that overwhelmed both the domestic carriers last financial year was largely due to their own irrational behaviour, with a flood of capacity generating a destructive capacity war within what should have been a profitable duopoly.

The cessation of that war earlier this year has seen capacity growth slow to negligible levels and yields and load factors stabilising. In a market where the domestic profit pool is between about $700m-$1bn a year, rational behaviour ought to see both Qantas and Virgin making money.

Similarly, the decline in the value of the Australian dollar and the impact of competition on the profitability of international routes has seen the rate of growth in capacity on the routes into and out of Australia slow markedly, helping to erase the roughly $500m a year of losses Qantas has been experiencing in its international business.

More significantly, Joyce has taken advantage of the crisis-like atmosphere that has surrounded the group over the past few years to deepen, broaden and accelerate a change program that aims to strip about $600m from the group's cost base this year. In the first half, the program produced $350m of benefit. The trauma of the past couple of years is producing substantial structural gains.

There are some further tailwinds to flow, as Qantas expects the benefit of lower oil and therefore fuel prices to be only $30m in the first half. It will get a much bigger boost in the second half as the level of participation in lower fuel prices within its hedging prices increases. That will be of particular and sizeable benefit to the group's international business.

The dramatic improvement in Qantas' position ought to be sustainable, at least in the near term.

Virgin, which incurred a pre-tax loss of about $260m last year, lost about $45m in the first quarter of the current year and now, having acquired the outstanding 40 per cent of Tiger Airways' Australia, has to absorb 100 per cent of its losses.

It was John Borghetti, having repositioned Virgin and completed the framework for a redesigned network, who effectively ended the capacity war.

With Air New Zealand (which has to equity account its share of Virgin's results), Etihad Airways and Singapore Airlines now within his boardroom, it is improbable that he or they would contemplate another bout of profit-shedding/loss-exacerbating conflict with Qantas.

The hockey-stick nature of Qantas' rebound to profitability ought to quell (but probably won't) the continuous calls for Joyce's departure from the group, despite the emerging impact of the controversial change program he has implemented. While it was horrendously costly, he has also retained Qantas' dominance of the domestic market.

Certainly his shareholders will be pleased at this point that he has stayed the course and that the calls for his sacking (which persist, despite the emerging success of the transformation program) have been stared down by his chairman Leigh Clifford and the rest of the board.

The Qantas share price has soared nearly 90 per cent in the past two months to its highest level in nearly four years. It rose about 11 per cent this morning, to $2.34, in response to the market update.

Joyce and the board would see that as a vindication of the difficult, costly and quite ruthless (and extremely controversial) strategies Joyce has pursued to try to stabilise and then re-make Qantas' position within very destabilising circumstances in both its domestic and international businesses.