Qantas sidesteps a terminal decline

Qantas’ result today provides the context for the massive job losses, deferrals and sales of aircraft, asset sales and big reductions in capital expenditure. At its most basic, Qantas’ earnings have imploded under the weight of capacity increases in all its core markets.

At the heart of the $252 million underlying pre-tax loss Qantas reported today was another blowout in the losses from its international business, a massive decline in the profitability of its Qantas domestic brands and heavy losses in Jetstar’s south-east Asian operations.

Qantas International, which had been reducing its losses, experienced a $171 million increase in its losses to $262 million. Qantas Domestic is still profitable, but earned only $57 million against the $218 million it generated in the previous corresponding period. Jetstar’s domestic operations remained profitable but were swamped by the losses in its Asian business and lost $16 million against the $128 million profit it achieved in the same half of 2012-13.

The common theme was the extent of capacity growth into soft markets, exacerbated by fuel costs and exchange rates.

In the domestic market Alan Joyce said today that over the past 18 months Virgin Australia had added 4.5 billion available seat kilometres to its capacity while the Qantas group had added 4.3 billion ASKs.

In the international market, he said, there had been 46 per cent growth in competitor capacity since 2009 – more than twice the global growth rate – and that growth had been driven primarily by state-owned airlines. In Asia, low-cost carrier capacity had increased 34 per cent.

In the circumstances, it isn’t surprising that Qantas suffered a 3 per cent decline in yield and experienced lower load factors, which stripped about $300 million from its earnings and overwhelmed the $190 million improvement in its cost base.

Part of the problem that has confronted Qantas since the financial crisis is that at the same time as there have been structural changes to the global aviation industry as the Middle Eastern hub carriers have expanded aggressively, the environment of weak global growth has seen capacity directed towards the one growth region, Asia Pacific, and towards the relatively strong Australian market and its Australian dollar earnings.

That has smashed its offshore earnings even as Virgin, backed by three of its biggest international competitors, has been adding capacity in the domestic market and upgrading its product to attract business and corporate travel and attack the yield premium at the core of Qantas’ domestic profitability. It is that yield premium that has, until now, offset Qantas’ legacy cost disadvantages.

Virgin couldn’t have sustained its increase in capacity and product improvements had it not been for the $350 million equity injection it received from shareholders – mainly its three strategic shareholders -- last year.

Tomorrow it will announce its own losses of close to $50 million, excluding further losses from its 60 per cent-owned Tiger Australia brand and restructuring costs.

In a relative sense, its losses are as bad as Qantas’ despite its more focused footprint and lower cost structure – which says that the domestic industry isn’t functioning rationally.

As Joyce said today, the result of the capacity increases (he said Virgin’s had been twice those of Qantas since mid-2011) is that the domestic profit pool has shrunk from more than $700 million in 2011-12 to less than $100 million in the first half of this financial year.

In a duopoly operating within reasonably stable economic conditions and within which the travel and airport businesses are producing solid results, that’s a bizzare situation.

While Qantas has sought help from the federal government – it wants the Qantas Sale Act, which uniquely restricts foreign investment in the group and restricts its ability to shift its maintenance operations offshore to lower-cost environments, to be amended and is asking for a government-guaranteed line of credit – it has no option but to accelerate the pace of change itself.

Qantas has already lowered its unit costs by about 20 per cent over the past four years but, with some overlapping of previously announced cost reduction programs, is now targeting $2 billion more in cuts over the next three years.

There is some urgency to the program. About 4000 of the 5000 reduction in full-time equivalent employees will occur by the end of next financial year. About 1500 of the positions are in management or non-operational roles. Executive wages have been frozen (Joyce’s pay has been cut by 36 per cent) and Qantas will try to extend the freeze to all its employees.

It is also slashing $1 billion from an already curtailed capital expenditure program in 2014-15 and 2015-16, deferring delivery or selling 50 planes as it accelerates the retirement of its older Boeing 747s and remaining 767s and defers delivery of the eight A380s and three B787-8s it still had on order.

Joyce announced the sale of the lease on its Brisbane terminal, to Brisbane Airport Corporation, for cash proceeds of $112 million today. Negotiations to sell the Melbourne terminal are said to be close to completion while similar discussions about the Sydney terminal are less developed.

As expected, while Qantas’ strategic review is continuing, no other assets sales or spin-offs were announced. Qantas, which has cash reserves of about $2.4 billion, is also looking at its options for releasing cash from its loyalty program and Jetstar business and says that the review has so far identified a number of “high quality assets of significant value”.

Joyce has been the focus of vitriolic criticisms from Qantas unions, politicians and others who don’t appear to be prepared to accept the extent to which the industry, both international and domestic, has changed in recent years or to recognise the implications of those changes for an end-of-the-line legacy carrier with legacy cost structures and government and labour-imposed limitations on its flexibility.

Qantas, due to the strength of its domestic franchise, has been able to cope with the impacts of change while, under Geoff Dixon and then Joyce, continuously changing and restructuring to lower costs and adapt its strategies to the new competitive landscape.

It is the clever attack on its strengths, devised and aggressively executed by one of its own former key executives, John Borghetti, and now largely funded by Air New Zealand, Singapore Airlines and Etihad Airways, that has decimated its domestic profits and, because it has coincided with the reversal of the improvement in its international business, destabilised the entire group.

Regardless of whom the chief executive of Qantas might be at this point in its history, its condition and its vulnerability dictates that it take radical, even brutal, measures to regain control of its own destiny. Nevertheless, there is likely to be a backlash and resistance from unions, some politicians and others to the scale of the job losses and changes unveiled today.