Qantas' wild capacity chase
Qantas chief executive Alan Joyce is adamant the airliner must maintain a 65 per cent share of the domestic market over the long term. While this strategy has proven profitable in previous years, Virgin Australia’s aggressive expansion plans in light of a fresh capital injection may mean Qantas need to rethink its plans to continue doubling any new capacity Virgin add.
At a time when airline capacity is expanding at a faster pace than actual demand, there are going to be losses incurred along the way. At the moment it is both Qantas and Virgin that are losing as their competitive intentions are melting profitability away.
Qantas continuing to add capacity, even as demand is not there to support additional seats, is reminiscent of a move to coerce Virgin to cease capacity growth. Unfortunately for Qantas, Virgin now has the financial capacity to continue an aggressive expansion and won’t be changing strategy anytime soon.
November trading conditions deteriorated, heightening the extent of Qantas’ forecast losses in an already tough market. In effect, Qantas’ strategy to double any new capacity Virgin add is crimping the yield they can achieve and consequently profitability. As a result, Qantas is in part responsible for its own fate.
Between Joyce’s opaque response to questions on Sky News and the company's market update, Qantas appears to be in deflection mode and lists the Australian aviation market as the toughest anywhere in the world. The domestic market has moved on from the monopoly Qantas once thrived in.
Perhaps it is time for Qantas to consider alternative profit-maximising strategies with a smaller, more sustainable share of the market. Repercussions of Qantas’ forecast will likely result in free cash flow being pushed into negative territory, or close to it. With $2.829 billion on hand at June 30, liquidity doesn’t appear to be of immediate concern, but Qantas’ can’t sustain losses as forecast today.
It is feasible the credit rating will come under pressure at some stage in the near future, as it did following the 2012 profit downgrade, pushing up future funding costs. The possibility of a capital raising is certainly valid, but would likely depend on the urgency for cash or if market conditions were conducive.
Qantas’ strategy to expand in an environment where demand is falling is proving to be costly for investors. Focus should now shift to Qantas’ ability to maintain market share over the long term, as it doesn’t look like Virgin will relent on its strategy anytime soon.