The armour plating Qantas needs

Qantas CFO Gareth Evans has delivered a none-too-subtle message to Virgin that it has no intention of backing down in the capacity and price war. The airline’s strategic review could change the rules of battle.

When Qantas chief financial officer Gareth Evans penned his opinion piece for Fairfax Media newspapers this week, was his message directed at their readers, politicians, the airline’s critics or, perhaps, Qantas’ competitor?

It is, of course, possible that he was trying to reach all of those audiences with his rebuttal of criticisms of the group’s approach to the Federal Government for help, its Jetstar brand and its Asian strategy.

He pointed to Qantas’ substantial cost reduction program, the profitability of Jetstar and the value of its equity positions in Asia in response to accusations the group was looking for handouts rather than taking hard decisions, that Jetstar has been cannibalising the parent brand and that Qantas has been pouring capital into loss-making Asian ventures.

The more fundamental issue he addressed, however, was the view that Qantas and Jetstar should stop targeting and defending the group’s 65 per cent “line-in-the-sand’’ market share threshold.

“The 65 per cent strategy is about giving our customers a market-leading choice of destinations, frequencies and seats at the times they want to travel,” he said.

“That scale is part of the premium service we offer and the fares we sell and it reflects the investment we have made over many years in our regional operations and in building a national low-fares network with Jetstar.

“It is prized by our customers and it is a real competitive advantage that allows us to maximise earnings in even the toughest market conditions.

“Stepping back from the 54 per cent would effectively be waving the white flag, not to mention abandoning our role in regional Australia and betraying the loyalty of our frequent flyers. Anyone who advocates this kind of approach does not understand the way the business works. We plan to keep strengthening our competitive advantages, not walking away from them,” he wrote.

As discussed on several occasions recently, Qantas can’t afford not to defend that line-in-the-sand. With a higher cost base than Virgin Australia it has to have the frequency advantage and a network coverage advantage that delivers it dominance of higher-yielding fares.

If it were to lose that dominance, given the cost disadvantages of a legacy airline relative to one that started with a clean sheet of paper, it would be heading down a one-way route to oblivion.

Evans wasn’t going to say that, of course, although Standard & Poor’s “hypothetical” default scenario for Qantas that was issued this week as it confirmed the group’s BB credit rating was predicated on intensifying competition through to 2019, as well as weak economic conditions, higher fuel prices and external shocks.

The key to Qantas returning to profitability and stability is to convince Virgin Australia and its three foreign strategic shareholders – Singapore Airlines, Air New Zealand and Etihad Airways – that maintaining a capacity and price war in a duopoly market is pointless and destructive for both groups.

It also needs to show it can withstand indefinitely whatever Virgin throws at it, which is where its strategic review, where nothing has been ruled out, could be critical. If it raises a big lump of cash from selling some of its equity in its frequent flyer program, or some parts of Jetstar, or selling its terminals, it would have an enhanced ability to stare down Virgin.

There are already signs that Virgin’s capacity growth has slowed considerably. John Borghetti has, with the acquisitions of Skywest and control of Tiger Australia and the investment in upgrading Virgin’s product – as well as the capital infusion from his key shareholders – transformed his group.

It is, however, also losing money and the broader economy is facing some challenges this year that could bring their own pressures to bear on the industry.

If there is no near-term strategic gain from competing too aggressively with Qantas – if it is clear that Qantas, as Evans’ commentary indicates – isn’t going to surrender its dominant market share almost regardless of the cost – Virgin might be convinced to take a longer term, incremental approach to chipping away at Qantas’ position while seeking to generate profitability for its own shareholders.

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