THE DISTILLERY: Qantas inquisition

Jotters ask 'what went wrong' ahead of Qantas' profit downgrade, while others put yesterday's rate cut into a global perspective.

The problems facing Qantas, especially its international arm, are well known. However, two commentators argue that the abruptness of the airline’s profit downgrade – sorry, "update” – raises serious questions about how chief executive Alan Joyce has managed the market’s expectations. Then again, no matter how hard the international aviation market is, a problem now reserved for Simon Hickey, Qantas cannot afford to part with it its overseas arm.

Starting with The Australian’s John Durie, it looks strange in retrospect that the market was expecting anything else from Qantas.

"The rising fuel bill didn't come out of left field. Nor did increasing international competition. Yet, somehow, the market was left thinking Qantas would report a pre-tax profit of $250 million to $400 million. That is bad investor relations and presumably meant to maximise the shock and awe impact Joyce wanted to have in showcasing that the international division is a basket case. It is far better to take the machete to wasteful, outdated work practices and clear external, political and community hurdles to your moves, if you can first show them all how much money you are losing. Once, a Sydney-to-London flight generated $1m in revenue. Now it costs $500,000-plus in fuel before you factor in the costs of the plane and its staff. But isn't this the same Qantas boss who not so long ago was boasting about his fleet expansion and upgrades?”

The Australian Financial Review’s Chanticleer columnist Tony Boyd expresses similar concerns, although the writer at least entertains the idea that Joyce and his fellow senior executives were brought undone by a "perfect storm” of factors over the last ten weeks.

"This will result in underlying profit before tax for the year to June 2012 being 90 per cent below market expectations at between $50 million and $100 million. The perfect storm included the dumping of capacity in Australia by European airlines, a sharp rise in jet-fuel prices, a decline in bond rates and movements in the Australian dollar. Joyce says the company first noted a potential hit to profits when bond rates started to decline in mid-March. The lower bond rates feed into lower discount rates for calculating the company’s provisions and that will lead to a non-cash provision of $50 million. However, he went on to say that the full extent of the red ink in both cash and non-cash terms was not known until Monday. But it seems implausible that management did not know sooner what was happening to earnings in its international operations. Other airlines are known to get a weekly update at executive committee meetings of performance. If numbers are slipping or not up to scratch, hard questions are asked.”

Business Spectator’s Stephen Bartholomeusz points out that the timing of the downgrade is appropriate, because it underlines the scale of the task facing the carrier’s inaugural international boss, Simon Hickey.

"The extent of the challenge Alan Joyce has handed Simon Hickey became clear today with the shock disclosure that Qantas International is generating a destabilising deluge of red ink that will nearly wipe out the Qantas group’s earnings this year… Losses of $450 million a year before interest and tax are unsustainable and explain why Joyce has been acting with increasing urgency to restructure the group’s cost base, scale back its international footprint and cut back on capital expenditure by deferring scheduled deliveries of new aircraft. The performance of the international business will almost completely wipe out the strong profitability of the core Qantas and Jetstar domestic operations, with Qantas now expecting to report earnings before interest and tax for the financial year of only $50 million to $100 million. Hickey, who previously headed the very profitable Qantas frequent flyer business, was given the hospital handpass of the CEO role for the international business in last month’s radical management restructure that split the group into four main and quite discrete business units. Today’s announcement says that the task ahead of him in stabilising the business is daunting but urgent.”

And The Sydney Morning Herald’s Elizabeth Knight addresses the question that many onlookers are asking. Why stay in the international market, with just 17 per cent market share, if it’s costing you $450 million? Surely, it makes more sense to pull out of the market altogether.

"According to Joyce, the calculation is not that clean. While Qantas International has a relatively small market share overall, its share of the premium market is significantly larger. The business or premium market is the nirvana for all operators as they are the high-yielding end of the market. Not only do the premium domestic customers want to be able to use their frequent-flyer points on international, they also want to use their international points for domestic use. Thus the highly profitable frequent-flyer division and the domestic premium Qantas brand both need the sustenance of Qantas International.”

Meanwhile, on a story Joyce would certainly be interested in, The Australian Financial Review’s Matthew Stevens says Etihad Airways appears to have cruised through expectations that a stake in Virgin Australia would require Foreign Investment Review Board approval.

Of course the other big news yesterday was the Reserve Bank’s 25 basis point cut and, as expected, there’s a deluge of business commentary on the unsurprising statement that accompanied it.

The Sydney Morning Herald’s Jessica Irvine points out that economic data set for the next two days, particularly Friday’s quarterly accounts, is expected to vindicate the RBA’s decision to cut by 25 basis points rather than 50. In a separate piece to his Qantas analysis, Business Spectator’s Stephen Bartholomeusz suggests that the RBA could have kept rates on hold to wait for the impact of last month’s action to take effect and the picture in Europe to crystallise – but it’s clearly worried about Europe now and that’s understandable.

The Age’s Malcolm Maiden makes a similar case by pointing out that there’s been a significant deterioration in market sentiment since the big May cut, which means this reduction reflects the fear within the RBA – although it’s hardly a panic. The Sydney Morning Herald’s economics editor Ross Gittins argues that, if RBA Governor Glenn Stevens were truly worried, he’d have slashed rates yesterday.

The Australian’s economics editor David Uren acknowledges that the RBA is concerned about Europe, but argues that it’s the deterioration in its outlook for China that’s the most important development. Fellow News Limited writer Richard Gluyas warns that Australia’s bank customers are set to pay the price for our banking profitability.

And The Sydney Morning Herald’s Michael Pascoe counters the argument that the central bank is playing catch-up with past over-estimations about the domestic economy.

In other economic news, The Australian Financial Review’s economics editor Alan Mitchell says the "automatic stabilisers” that opposition leader Tony Abbott refers to in the wake of another global downturn might be a little exhausted this time around. In a separate piece to his interest rate comment, David Uren points out that Treasury might have more to learn from the recession of the 1990s for this coming downturn than the GFC. Meanwhile, The Australian’s Barry Fitzgerald says the sell-off in oil and gas shares might have been a bit overdone and some bargains could be out there.

In company news, The Australian’s Bryan Frith says the decision by Brambles to opt for a capital raising is an encouraging sign that corporate Australia is recognising a recently introduced structure is offering equality for all shareholders. In a separate piece to her Qantas insight, the SMH’s Elizabeth Knight says Brambles is right to hold on to US document management business Recall after being unable to find a credible buyer.

Meanwhile, Fairfax’s Insider columnist Ian McIlwraith looks at the debate between Perpetual and the Robert Millner allies about the cross-ownership of Brickworks and Washington H Soul Pattinson.

And finally, Fairfax’s China correspondent John Garnaut reports that the phrases "Shanghai Composite Index” and "stock market” have been added to the bulging list of banned search terms in China in the wake of the index’s protest against the Tiananmen Square massacre. The anniversary was June 4.