The extent of the challenge Alan Joyce has handed Simon Hickey became clear today with the shock disclosure that Qantas International is generating a destabilising deluge of red ink that will nearly wipe out the Qantas group’s earnings this year.
While it was known that the international business was haemorrhaging – it lost $216 million last financial year – the scale of the losses Qantas disclosed today was completely unexpected and sent Qantas shares into a tailspin.
Losses of $450 million a year before interest and tax are unsustainable and explain why Joyce has been acting with increasing urgency to restructure the group’s cost base, scale back its international footprint and cut back on capital expenditure by deferring scheduled deliveries of new aircraft.
The performance of the international business will almost completely wipe out the strong profitability of the core Qantas and Jetstar domestic operations, with Qantas now expecting to report earnings before interest and tax for the financial year of only $50 million to $100 million.
Hickey, who previously headed the very profitable Qantas frequent flyer business, was given the hospital handpass of the CEO role for the international business in last month’s radical management restructure that split the group into four main and quite discrete business units. Today’s announcement says that the task ahead of him in stabilising the business is daunting but urgent.
As if to underscore the nature of that challenge, Etihad Airways disclosed today that it has acquired a 3.96 per cent stake in Virgin Australia. It was able to buy onto a register already crowded with Qantas’ rivals because of the recent Virgin Australia restructuring, which quarantined the group’s international operations – subjected to foreign ownership limits – from its domestic operations.
Already on the Virgin register are Richard Branson (26 per cent) and Air New Zealand (20 per cent). Etihad, like Air NZ, Singapore Airlines and Delta Airlines, has struck an alliance with Virgin Australia as part of John Borghetti’s strategy of creating a virtual international network to enable his group to better compete with Qantas.
Qantas’ competitors are coalescing around Borghetti, a one-time rival to Joyce for the Qantas CEO post.
Borghetti understands Qantas’ vulnerability and, with its international flank exposed, will continue to ratchet up the pressure both through the leverage created by the international alliances and by ramping up his assault on the critical Qantas domestic segment, its dominance of domestic business travel.
The issues confronting Hickey are many and varied.
The central issue is the continual loss of market share on what were formerly core routes, as Qantas has come under attack from newer, more efficient competitors with newer, better and more fuel-efficient fleets.
Qantas’ legacy cost structures, last year’s costly industrial disputes (which cost it the best part of $100 million), the strength of the Australian dollar and the soaring cost of jet fuel (which Qantas said will reach $4.4 billion this year, a $700 million increase) are other negative influences on its performance.
The attempt to transform Qantas is proving quite painful and costly. Apart from last year’s bitter industrial disputes, that ended only when Joyce took the extraordinary step of grounding his entire fleet, there are continuing heavy job losses – 500 heavy engineering job cuts were announced last month – and continuing resistance from key unions to the attempts to create a sustainable international business.
The program also has a financial cost – Qantas said there would be one-off costs of $370 million to $380 million this year, albeit more than half of them non-cash items – and the $900 million of cut backs to capital expenditure will delay the displacement of the group’s ageing fleet by desperately needed newer and more efficient planes. Joyce said capital expenditure in 2013-14 would be at a similar level to the $1.9 billion the group will spend this year, or lower.
Qantas, of course, isn’t alone. Most of the international carriers are struggling as the eurozone’s economic woes and the weakness of the US combined with record jet fuel prices continue to throttle industry profitability, which even in better times is weak.
As an end-of-the-line carrier in a region that represents one of the few bright spots in the international industry, with an ageing fleet, confronted with competition from hub carriers deploying ever-increasing state-of-the-art capacity on routes into and out of this market and under challenge in its domestic market from a brand headed by someone who knows it intimately Qantas, however, faces some particular and particularly complex threats.