Qantas struggles through a cloud of unknowns

Qantas' determination to do whatever it takes to defend its domestic market share against Virgin Australia's assault has been given a context by today's plunge into the red. It says something about the strength of the domestic franchise that the $245 million loss wasn't far worse.

During the financial year Qantas had to wear the $194 million cost of the bitter industrial dispute with three of its unions that led to the grounding of its fleet; it had to cope with a $645 million increase in an already inflated fuel bill; it had to absorb $198 million of redundancy and restructuring costs and it took $147 million of write-downs. The Qantas international business lost $450 million.

In the circumstances, holding the statutory loss to $250 million, Qantas' first since its privatisation 17 years ago, meant Qantas was able to avoid being completed destabilised by the worst confluence of circumstances in its history as a listed entity.

That it was able to manage the impacts of those influences on its performance was due to the strength of the domestic businesses, which Alan Joyce said generated underlying earnings before interest and tax of more than $600 million.

Qantas doesn't break up the Qantas-branded domestic business' results but Jetstar's underlying earnings were up 34 per cent to $203 million. On an underlying basis the Qantas brand lost $21 million which, given the massive losses within the international business, provides an indication of just how profitable Qantas Domestic is.

Qantas is planning to increase domestic capacity by between 9 and 11 per cent this year to counter the capacity Virgin's John Borghetti is pouring into the market in his attempt to wrest market share from Qantas, particular within Qantas' core business travel segment.

Joyce readily concedes that will impact yields but is adamant that Qantas will do whatever it takes to defend the 65 per cent share that Qantas believes is critical to maximising its domestic profits. He also claimed that Qantas is winning back corporate customers that had defected to Virgin.

The group outcome, an underlying profit of $95 million ($552 million previously) was aided by a solid performance from the Qantas frequent flyer program, which contributed $231 million, a 14 per increase on the previous year once a change in the way its earnings are accounted for is taken into account. It is, however, the condition of the international business that will dictate Qantas' future.

Joyce said today that the result represented an "inflection point" in the group's circumstances. Presumably he believes that the shape of the Qantas curve, which has been dragged downwards by the haemorrhaging within the international business, is turning positive.

There is, of course, an enormous amount of restructuring of that business, its routes and its heavy maintenance facilities, occurring.

An encouraging sign, however, was that Qantas was generating positive free cash flow in the second half. Qantas is highly liquid, with $3.4 billion of cash to tide it through the restructuring so positive free cashflow ought to enable it to pay down some debt and strengthen its balance sheet as insurance against the uncertainty in its operating environment.

Joyce unveiled yet another piece of the restructuring jigsaw today with a major restructuring of his fleet plan, the centrepiece of which was the cancellation of what had been 35 firm commitments for the new Boeing 787-9. Qantas is also bringing forward 50 options and purchase rights for the plane by two years, which would enable it to get access to them in 2016.

The effect of the changes to the delivery schedules for the B787-9s is to delay the first deliveries by two years. The original schedule had already been set back by two years because of problems encountered by Boeing during the construction phase, allowing Qantas to cancel the orders without penalty and, indeed, giving it access to liquidated damages.

Not only will the restructuring of its fleet plan reduce its future capital expenditure commitments by $US8.5 billion but there will be a cash inflow of $US433 million, $US355 million of it this financial year and a handy $US140 million boost to first half earnings.

Apart from the financial impacts of the decision to cancel the earlier deliveries it fits within the Qantas thinking about its international business.

It is aiming to get that business to break-even by 2015 and until it reaches that point it is difficult to justify a big investment in new planes, even though the 787-9s are a far more modern and fuel-efficient product than the ageing 747s it now flies and would both lower its costs and provide it with a more competitive international product.

A potential key to the ability of the international business to get to profitability, apart from some improvement in the global economic circumstances, is some form of alliance with Emirates that would give Qantas access to a far larger range of routes into Europe and turn a threatening competitor into an ally. Joyce, however, was reluctant to make any meaningful comment on the status of those discussions.

While it has cancelled the 35 787-9s on firm order (although its options involve firm delivery dates and fixed prices) Qantas will go ahead with the deliveries of 15 B787-8s for Jetstar, with the first of those planes arriving in the second half of next year. As they start arriving Jetstar's A330s will be transferred to Qantas domestic and will eventually enable Qantas to retire its Boeing 767 fleet.

Joyce pre-emptively defended the group against criticism of the decision to defer the introduction of the 787-9s, saying that at 8.3 years the average age of the fleet was the lowest since its privatisation and was competitive by international standards. A problem for Qantas, of course, is that the Middle Eastern carriers have far newer and more sophisticated fleets with lower operating costs.

The broader picture for Qantas remains cloudy. Apart from the gloomy economic backdrop, it is in the midst of a massive restructuring, its international strategies – both for Qantas and Jetstar – are still only half-formed and its domestic business is under attack.

The 2012-13 financial year will be a very significant one in Qantas' history. It actually does need to provide the positive inflection point Joyce is hoping for.