Qantas losing altitude on recovery route

Given the extent and the variety of the turbulence that has been buffeting airlines this year, Qantas' profit update today came as a positive surprise.

While its forecast of underlying profit before tax for this year, within a range of $500 million to $550 million, was slightly below market expectations, those expectations were shifting down as a series of natural disasters, weak consumer spending, and high jet fuel prices that have impacted airline earnings.

It hadn't helped that airlines around the world, including the two big domestic carriers, had been adding capacity in anticipation of an even stronger rebound in demand than has occurred.

Qantas calculates its own losses from "weather events” and natural disasters at $206 million, including $21 million from the disruptions created by the ash from the Chilean volcano that are again creating havoc with its schedules. Those were only partly offset by a $95 million settlement with Rolls-Royce over the incident that led to the grounding of Qantas' A380 fleet last year.

Even with the losses, Alan Joyce was able to say that the forecast result would be the group's best since the onset of the global financial crisis.

That's not to say that there isn't a major problem within Qantas. Joyce has been saying, with increasing stridency, that something has to be done about Qantas' international business, which has structural problems.

He has a strategic review under way that is scheduled to be completed later this year and which is expected to lead to some potentially radical changes in Qantas' international operations and strategy, including a particular focus on expanding its presence throughout Asia.

The need for change was underscored by his disclosure that Qantas International was expected to lose about $200 million this financial year on invested capital of more than $5 billion.

That is self-evidently unsustainable, particularly as the business has a long track record (broken, Joyce said, only three times in 15 years) of not returning its cost of capital.

With Joyce saying he expected an even weaker result next year, tinkering with international routes and capacity while awaiting better times is clearly not a sufficient response to the challenges confronting the business. This includes a quite dramatic increase in competition on the routes that have traditionally been its most profitable.

Its poor performance also helps explain why Joyce has cut back planned international capacity growth, as well as his unyielding stance in response to threats of industrial action by Qantas unions.

Mind you, the business is in "good” company. The International Air Transport Association slashed its forecasts for international airline profits this year by 76 per cent as a result of the high fuel costs and an over-optimistic increase in global capacity.

Even in the Asia-Pacific region, which has been the fastest-growing and most profitable region through the crisis, its expectations of earnings have plummeted, with the carriers expected to earn a fifth of the $US10 billion they made last year.

Qantas' ability to forecast a solid underlying profit in the circumstances (Virgin Australia has foreshadowed a significant loss) is due to the strength of its domestic franchise and its frequent flyer business in particular. The loyalty program has provided a very solid and growing core of earnings in recent years to offset the volatility – generally weighted to the downside -- of the airline operations.