Qantas shakes off an airline dogfight

Dramatic cost restructuring in its international arm carried Qantas relatively unscathed through a brutal second half. Provided Virgin doesn’t reignite its capacity war, it should be smoother sailing ahead.

Qantas has survived a second-half dogfight with Virgin Australia to scrape into the black for the year to June. It did, however, take some hits in a capacity war that is now abating.

On Qantas’s preferred measure, underlying profit before tax, it posted a $192 million profit, which implies a $31 million second-half loss given that in the first half it reported a $223 million profit on the same basis. On a statutory basis, net profit was a modest $6 million compared with a $111 million first-half profit.

Given that Virgin Australia shocked the market earlier this month with its second downgrade in four months, saying it expected to post an after-tax loss of between $95 million and $110 million for the year to June with a pre-tax loss of between $30 million and $50 million, Qantas’ second-half downturn wasn’t unexpected and was even somewhat better than anticipated. Virgin Australia had underlying pre-tax profits of $61 million in its first half, providing an indication of how tough the second six months was.

It was Virgin Australia that ignited the capacity war with Qantas, but the rival carrier was taken aback by the ferocity and nature of Qantas’ response, with Alan Joyce using his Jetstar brand to spearhead his counter-attack. Jetstar’s domestic business added almost 12 per cent to its capacity in the year to June as Joyce targeted Virgin Australia’s still-core customer base – leisure travellers.

There was, obviously, a cost to that response and the defence of Qantas’ ‘line in the sand’ within the domestic market – a minimum market share of 65 per cent. The underlying earnings before interest and tax of Qantas’ domestic brand fell from $463 million to $365 million, while the Jetstar group, which includes the carrier’s international operations, experienced a fall in EBIT from $203 million to $138 million.

With both the domestic carriers having cut back sharply on capacity growth rates the market appears to be stabilising, proffering a more profitable start to this financial year within their domestic operations.

What saved Qantas from what might otherwise have been an ugly outcome was the impact of a traumatic and quite radical restructuring of its international business and Joyce’s re-basing of the group’s costs more broadly.

A year ago Qantas revealed that its international business had lost $484 million. In the latest financial year those losses were cut by almost 50 per cent to $246 million.

While there have been some negative impacts from the costs associated with the historic alliance with Emirates as Qantas moved its offshore hub from Singapore to Dubai, the full benefits of that alliance – and the impact of Qantas redeploying capacity released by the alliance into a more business-friendly schedule in Asia – have yet to be realised.

The overall impact of Joyce’s focus on costs showed up in a mere one per cent increase in operating expenses and an impressive five per cent reduction in comparable unit costs. Qantas said its “transformation” program had delivered $428 million of benefit to underlying EBIT as it exited unprofitable routes, reconfigured its fleet and consolidated its engineering and catering operations. It is pursuing cumulative benefits of $300 million from the program this financial year.

The Qantas loyalty program was again a stellar performer, lifting its underlying EBIT 13 per cent to a record $260 million. The program is in the midst of another aggressive expansion, with the launch of a new multi-currency cash card, the relationship with Emirates and continuing growth in the number and range of its partners.

There were some material items excluded from Qantas’ underlying result – $118 million for redundancies and restructuring, for instance – while the underlying result included the settlement with Boeing for late delivery of the Dreamliners and changes to the way the group recognises revenue for tickets that have passed their scheduled travel date, as well as the cost of shifting the hub for European flights to Dubai and losses from Jetstar’s Asian start-ups. The net effect of those items on underlying earnings was $40 million.

Qantas, not surprisingly, isn’t providing guidance for this financial year. It would be a brave airline chief executive who did try to forecast what conditions might be like over the course of 12 months is such a volatile industry, with currency fluctuations, dynamic fuel prices, question marks over the economic outlook both at home and offshore, and an international business still in transition.

Qantas is, however, forecasting capacity growth of only one to two per cent in the first half and domestic capacity growth of 1.5 per cent to 2.5 per cent. That would suggest Joyce thinks his bruised counterpart at Virgin Australia, John Borghetti, isn’t likely to launch another capacity-driven assault on Qantas’ domestic stronghold.

Borghetti himself has effectively indicated that, having settled his premium offering on the east-west routes and concluded his acquisitions of Tiger Airways Australia and SkyWest, he is now playing a longer-term game, with no plans to significantly ratchet up his flagship brand’s capacity in the near term.

If that is the case, and assuming Qantas continues to reduce, or at least stabilise, the losses in its international business, more settled domestic skies ought to see both the major airlines having a better first half this financial year than they produced in that brutal second half of the year just ended.

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